Special Report On The U.S. Rating Downgrade ... - Standard & Poor's

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Special Report
On The
U.S. Rating Downgrade
And Its
Global Effects

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Features
3
August 17, 2011 | Volume 31, No. 31
Special Report
U.S. Long-Term Rating Lowered To ‘AA+’;
Outlook Negative
By Nikola G. Swann, Toronto
8 Transcript Of Standard & Poor’s Teleconference Held
On Aug. 8, 2011: United States of America Long-Term
Rating Lowered To ‘AA+’, Outlook Negative
By David T. Beers, London
David Beers, global head of sovereign ratings and
managing director; and John Chambers, managing
director and chairman of the sovereign ratings committee,
discuss key reasons for the U.S. downgrade. They explain,
among other things, the baseline assumption Standard &
Poor’s used to arrive at the rating decision, and what
would it take for the U.S. to return to a ‘AAA’ rating.
17 U.S. Sovereign Rating Downgrade Has Knock-On
Effects For Some Borrowers
By Curtis Moulton, New York
While we don’t view sovereign ratings as
ceilings for other entities, sovereign
credit risk is a key factor in nonsovereign
ratings because the wide-ranging powers
and resources of a government can affect
the financial, operating, and investment
environments of entities under its jurisdiction.
Credit FAQ
22 Understanding Ratings Above The Sovereign
By Laura Feinland Katz, New York
Due to heightened interest in our approach to issuing
ratings that are above the sovereign’s for governmentrelated
entities, banks, insurers, corporations, state,
regional, or local governments, and securitizations, we
clarify in this article our methodologies, provide
examples of how we put them into practice, and answer
frequently asked questions.
The downgrade on the United States of America reflects our opinion that
the fiscal consolidation plan that Congress and the Administration
recently agreed to falls short of what would be necessary to stabilize the
government’s medium-term debt dynamics. More broadly, the downgrade
reflects our view that the effectiveness, stability, and predictability of
American policymaking and political institutions have weakened at a time
of ongoing fiscal and economic challenges.
28 U.S. Downgrade Doesn’t Currently Affect Top-Rated
U.S. Nonfinancial Corporate Borrowers
By Ronald M. Barone, New York
The sovereign downgrade will not affect the ratings or
stable rating outlooks on the six U.S.-domiciled highestrated
nonfinancial corporate issuers: ExxonMobil Corp.,
Johnson & Johnson, Microsoft Corp., General Electric
Co., Automatic Data Processing Inc., and W.W.
Grainger Inc.
31 Rating Actions Were Taken On 10 U.S.-Based
Insurance Groups
By Neal Freedman, New York
Our view of these companies’ fundamental credit
characteristics has not changed. Rather, the rating
actions reflect the application of criteria and our view
that the link between the ratings on these entities and
the sovereign credit ratings on the U.S. could lead to a
decline in the insurers’ financial strength. This is because
these companies’ businesses and assets are highly
concentrated in the U.S.

33 State And Local Government Ratings Are Not Directly
Constrained By That Of The U.S. Sovereign
36 Ratings On Certain Public Finance Debt Issues With
FHA Mortgage Guarantees Are Placed On
CreditWatch Negative
37 The Deficit Remedy Could Be Toxic For U.S. Health
Care Companies
43 Not-For-Profit Health Care Ratings: No Immediate
Direct Impact, But Longer-Term Questions Remain
46 Certain Public Housing Authority Government-
Related Entity Ratings Lowered
46 Ratings On Certain Municipal Housing Issues
Lowered To ‘AA+’
47 Ratings On U.S. Municipal Housing Issues
Guaranteed By Fannie Mae And Freddie Mac Lowered
To ‘AA+’
47 Ratings On Municipal Housing Issues Backed By The
U.S. Government Are Lowered To ‘AA+’
48 Ratings On Energy Northwest, WA And Bonneville
Power Administration, OR Lowered To ‘AA-/Stable’
49 Tennessee Valley Authority Rating Lowered To ‘AA+’
After U.S. Downgrade; Outlook Is Negative
50 Ratings On Select GREs and FDIC- And NCUA-
Guaranteed Debt Lowered After Sovereign
Downgrade
52 Ratings On The U.S. Central Securities Depository
And Three Clearinghouses Lowered
53 U.S. Military Exchange Services Lowered To ‘AA-‘
After Sovereign Downgrade
55 Asia-Pacific Sovereigns: Not Directly Affected But
Long-Term Consequences Could Be Negative
57 U.S. Downgrade Has No Immediate Impact On Asia-
Pacific Ratings
58 Transcript Of Teleconference Held On Aug. 10, 2011
The Impact Of Standard & Poor’s U.S. Downgrade On
Other Asset Classes
67 State And Local Governments Face Fiscal Challenges
Under Federal Debt Deal

U.S. Long-Term Rating
Lowered To ‘AA+’;
Outlook Negative
Overview
We have lowered our long-term sovereign credit rating on the United States of America
to ‘AA+’ from ‘AAA’ and affirmed the ‘A-1+’ short-term rating.
We have also removed the short- and long-term ratings from CreditWatch negative.
The downgrade reflects our opinion that the fiscal consolidation plan that Congress
and the Administration recently agreed to falls short of what, in our view, would be
necessary to stabilize the government’s medium-term debt dynamics.
More broadly, the downgrade reflects our view that the effectiveness, stability, and
predictability of American policymaking and political institutions have weakened at a
time of ongoing fiscal and economic challenges to a degree more than we envisioned
when we assigned a negative outlook to the rating on April 18, 2011.
Since then, we have changed our view of the difficulties in bridging the gulf between the
political parties over fiscal policy, which makes us pessimistic about the capacity of
Congress and the Administration to leverage their agreement into a broader fiscal consolidation
plan that stabilizes the government’s debt dynamics any time soon.
The outlook on the long-term rating is negative. We could lower the long-term rating to
‘AA’ within the next two years if we see that less reduction in spending than agreed to,
higher interest rates, or new fiscal pressures during the period result in a higher general
government debt trajectory than we currently assume in our base case.
Standard & Poor’s Ratings Services lowered its long-
term sovereign credit rating on the United States of
America to ‘AA+’ from ‘AAA’. The outlook on the
long-term rating is negative. At the same time, Standard &
Poor’s affirmed its ‘A-1+’ short-term rating on the U.S. In
addition, Standard & Poor’s removed both ratings from
CreditWatch, where they were placed on July 14, 2011,
with negative implications.
Standard & Poor’s CreditWeek | August 17, 2011 3

features special report
In response to questions, Standard & Poor’s Ratings Services said
that the ratings decision to lower the long-term rating on the
United States to ‘AA+’ from ‘AAA’ was not affected by the change
of assumptions regarding the pace of discretionary spending
growth. In the near-term horizon to 2015, the U.S. net general government
debt is projected to be $14.5 trillion (79% of 2015 GDP)
versus $14.7 trillion (81% of 2015 GDP) with the initial assumption.
We used the Alternative Fiscal Scenario of the nonpartisan
Congressional Budget Office (CBO), which includes an assumption
that government discretionary appropriations will grow at
the same rate as nominal GDP. In further discussions between
Standard & Poor’s and the U.S. Treasury, we determined that the
CBO’s Baseline Scenario, which assumes discretionary appropriations
grow at a lower rate, would be more consistent with
CBO assessment of the savings set out by the Budget Control
Act of 2011.
4 www.creditweek.com
The transfer and convertibility (T&C)
assessment of the U.S.—our assessment of
the likelihood of official interference in the
ability of U.S.-based public- and privatesector
issuers to secure foreign exchange
for debt service—remains ‘AAA’.
We lowered our long-term rating on the
U.S. because we believe that the prolonged
controversy over raising the statutory debt
ceiling and the related fiscal policy debate
indicate that further near-term progress
containing the growth in public spending,
especially on entitlements, or on reaching
an agreement on raising revenues is less
likely than we previously assumed and
will remain a contentious and fitful
process. We also believe that the fiscal
consolidation plan that Congress and the
Administration agreed to falls short of the
amount that we believe is necessary to stabilize
the general government debt burden
by the middle of the decade.
Our lowering of the rating was
prompted by our view on the rising public
debt burden and our perception of greater
policymaking uncertainty, consistent with
our criteria (see “Sovereign Government
Rating Methodology and Assumptions,”
published June 30, 2011, on RatingsDirect,
on the Global Credit Portal, especially
Paragraphs 36-41). Nevertheless, we view
the U.S. federal government’s other economic,
external, and monetary credit
attributes, which form the basis for the sovereign
rating, as broadly unchanged.
We have taken the ratings off
CreditWatch because the Aug. 2 passage
of the Budget Control Act Amendment of
2011 has removed any perceived immediate
threat of payment default posed by
delays to raising the government’s debt
ceiling. In addition, we believe that the act
provides sufficient clarity to allow us to
evaluate the likely course of U.S. fiscal
policy for the next few years.
The political brinksmanship of recent
months highlights what we see as
America’s governance and policymaking
becoming less stable, less effective, and less
predictable than what we previously
believed. The statutory debt ceiling and the
threat of default have become political bargaining
chips in the debate over fiscal
policy. Despite this year’s wide-ranging
debate, in our view, the differences between
political parties have proven to be extraordinarily
difficult to bridge, and, as we see it,
the resulting agreement fell well short of the
comprehensive fiscal consolidation program
that some proponents had envisaged
until quite recently. Republicans and
Democrats have only been able to agree to
relatively modest savings on discretionary
spending while delegating decisions on
more comprehensive measures to the Select
Committee. It appears that, for now, new
Standard & Poor’s Clarifies Assumption Used On Discretionary Spending Growth
Our ratings are determined primarily using a three- to fiveyear
time horizon.
In the near-term horizon, by 2015, the U.S. net general government
debt with the new assumptions was projected to be $14,455
billion (79% of 2015 GDP) versus $14,727 billion (81% of 2015 GDP)
with the initial assumption—a difference of $272 billion.
In taking a longer-term horizon of 10 years, the U.S. net general
government debt level with the current assumptions would be
$20.1 trillion (85% of 2021 GDP). With the original assumptions, the
debt level was projected to be $22.1 trillion (93% of 2021 GDP).
The primary focus remained on the current level of debt, the trajectory
of debt as a share of the economy, and the lack of apparent
willingness of elected officials as a group to deal with the U.S.
medium-term fiscal outlook. None of these key factors was meaningfully
affected by the assumption revisions to the assumed growth of
discretionary outlays and thus had no impact on the rating decision.

evenues have dropped down on the menu
of policy options. In addition, the plan
envisions only minor policy changes on
Medicare and little change in other entitlements,
the containment of which we and
most other independent observers regard as
key to long-term fiscal sustainability.
Our opinion is that elected officials
remain wary of tackling the structural
issues required to effectively address the
rising U.S. public debt burden in a
manner consistent with a ‘AAA’ rating
and with ‘AAA’ rated sovereign peers
(again, see “Sovereign Government
Rating Methodology and Assumptions,”
Paragraphs 36-41). In our view, the difficulty
in framing a consensus on fiscal
policy weakens the government’s ability
to manage public finances and diverts
attention from the debate over how to
achieve more balanced and dynamic economic
growth in an era of fiscal stringency
and private-sector deleveraging
(ibid). A new political consensus might
(or might not) emerge after the 2012 elections,
but we believe that by then, the
government debt burden will likely be
higher, the needed medium-term fiscal
adjustment potentially greater, and the
inflection point on the U.S. population’s
demographics and other age-related
spending drivers closer at hand (see
“Global Aging 2011: In The U.S., Going
Gray Will Likely Cost Even More Green,
Now,” published June 21, 2011).
Standard & Poor’s takes no position
on the mix of spending and revenue
measures that Congress and the
Administration might conclude is
appropriate for putting the U.S.’
finances on a sustainable footing.
The act calls for as much as $2.4 trillion
of reductions in expenditure growth over
the 10 years (through 2021). These cuts
will be implemented in two steps: the $917
billion agreed to initially, followed by an
additional $1.5 trillion that the newly
formed Congressional Joint Select
Committee on Deficit Reduction is supposed
to recommend by November 2011.
The act contains no measures to raise taxes
or otherwise enhance revenues, though the
committee could recommend them.
The act further provides that if Congress
does not enact the committee’s recommen-
dations, cuts of $1.2 trillion will be implemented
over the same time period. The
reductions would mainly affect outlays for
civilian discretionary spending, defense,
and Medicare. We understand that this fallback
mechanism is designed to encourage
Congress to embrace a more balanced mix
of expenditure savings, as the committee
might recommend.
We note that in a letter to Congress
on Aug. 1, 2011, the Congressional
Budget Office (CBO) estimated total
budgetary savings under the act to be at
least $2.1 trillion over the next 10 years
relative to its baseline assumptions. In
updating our own fiscal projections,
with certain modifications outlined
below, we have relied on the CBO’s
latest “Alternate Fiscal Scenario” of
June 2011, updated to include the CBO
assumptions contained in its Aug. 1
letter to Congress. In general, the CBO’s
“Alternate Fiscal Scenario” assumes a
continuation of recent Congressional
action overriding existing law.
We view the act’s measures as a step
toward fiscal consolidation. However, this
is within the framework of a legislative
mechanism that leaves open the details of
what is finally agreed to until the end of
2011, and Congress and the Administration
could modify any agreement in the future.
Even assuming that at least $2.1 trillion of
the spending reductions the act envisages
are implemented, we maintain our view
that the U.S. net general government debt
burden (all levels of government combined,
excluding liquid financial assets) will likely
continue to grow. Under our revised base
case fiscal scenario—which we consider to
be consistent with a ‘AA+’ long-term rating
and a negative outlook—we now project
that net general government debt would rise
from an estimated 74% of GDP by the end
of 2011 to 79% by 2015 and 85% by
2021. Even the projected 2015 ratio of sovereign
indebtedness is high in relation to
those of peer credits and, as noted, would
continue to rise under the act’s revised
policy settings.
Compared with previous projections,
our revised base case scenario now
assumes that the 2001 and 2003 tax
cuts, due to expire by the end of 2012,
remain in place. We have changed our
assumption on this because the majority
of Republicans in Congress continue to
resist any measure that would raise revenues,
a position we believe Congress
reinforced by passing the act. Key
macroeconomic assumptions in the base
case scenario include trend real GDP
growth of 3% and consumer price inflation
near 2% annually over the decade.
Our opinion is that elected officials remain
wary of tackling the structural issues required
to effectively address the rising U.S. public
debt burden…
Our revised upside scenario—which,
other things being equal, we view as consistent
with the outlook on the ‘AA+’ longterm
rating being revised to stable—retains
these same macroeconomic assumptions.
In addition, it incorporates $950 billion of
new revenues into the assumption that the
2001 and 2003 tax cuts for high earners
lapse from 2013 onward, as the
Administration is advocating. In this scenario,
we project that the net general government
debt would rise from an estimated
74% of GDP by the end of 2011 to 77%
in 2015 and to 78% by 2021.
Our revised downside scenario—
which, other things being equal, we view
as consistent with a possible further
downgrade to a ‘AA’ long-term rating—
features less-favorable macroeconomic
assumptions, as outlined below and also
assumes that the second round of
spending cuts (at least $1.2 trillion) that
the act calls for does not occur. This scenario
also assumes somewhat higher
Standard & Poor’s CreditWeek | August 17, 2011 5

features special report
6 www.creditweek.com
nominal interest rates for U.S. Treasuries.
We still believe that the role of the U.S.
dollar as the key reserve currency confers
a government funding advantage, one that
could change only slowly over time, and
that Fed policy might lean toward continued
loose monetary policy at a time of
fiscal tightening. Nonetheless, it is possible
that interest rates could rise if investors reprice
relative risks. As a result, our alternate
scenario factors in a 50 basis point
(bp) to 75 bp rise in 10-year bond yields
relative to the base and upside cases from
2013 onward. In this scenario, we project
the net public debt burden would rise
from 74% of GDP in 2011 to 90% in
2015 and to 101% by 2021.
Our revised scenarios also take into
account the significant negative revisions
to historical GDP data that the
Bureau of Economic Analysis
announced on July 29. From our perspective,
the effect of these revisions
underscores two related points when
evaluating the likely debt trajectory of
the U.S. government. First, the revisions
show that the recent recession was
deeper than previously assumed, so the
GDP this year is lower than previously
thought in nominal and real terms.
Consequently, the debt burden is
slightly higher. Second, the revised data
highlight the subpar path of the current
economic recovery when compared
with rebounds following previous postwar
recessions. We believe the sluggish
pace of the current economic recovery
could be consistent with the experiences
of countries that have had financial
crises in which the slow process of debt
deleveraging in the private sector leads
to a persistent drag on demand. As a
result, our downside case scenario
assumes relatively modest real trend
GDP growth of 2.5% and inflation of
near 1.5% annually going forward.
When comparing the U.S. to sovereigns
with ‘AAA’ long-term ratings that
we view as relevant peers—Canada,
France, Germany, and the U.K.—we
also observe, based on our base case scenarios
for each, that the trajectory of the
U.S.’s net public debt is diverging from
the others. Including the U.S., we estimate
that these five sovereigns will have
net general government debt to GDP
ratios this year ranging from 34%
(Canada) to 80% (the U.K.), with the
U.S. debt burden at 74%. By 2015, we
project that their net public debt to GDP
ratios will range between 30% (lowest,
Canada) and 83% (highest, France),
with the U.S. debt burden at 79%.
However, in contrast with the U.S., we
project that the net public debt burdens
of these other sovereigns will begin to
decline, either before or by 2015.
Standard & Poor’s transfer T&C
assessment of the U.S. remains ‘AAA’.
Our T&C assessment reflects our view
of the likelihood of the sovereign
restricting other public and private
issuers’ access to foreign exchange
needed to meet debt service. Although
in our view the credit standing of the
U.S. government has deteriorated modestly,
we see little indication that official
interference of this kind is entering the
policy agenda of either Congress or the
Administration. Consequently, we continue
to view this risk as highly remote.
The outlook on the long-term rating is
negative. As our downside alternate fiscal
scenario illustrates, a higher public debt
trajectory than we currently assume could
lead us to lower the long-term rating
again. On the other hand, as our upside
scenario highlights, if the recommendations
of the Congressional Joint Select
Committee on Deficit Reduction—independently
or coupled with other initiatives,
such as the lapsing of the 2001 and
2003 tax cuts for high earners—lead to
fiscal consolidation measures beyond the
minimum mandated, and we believe they
are likely to slow the deterioration of the
government’s debt dynamics, the longterm
rating could stabilize at ‘AA+’. CW
For more articles on this topic search RatingsDirect with keyword:
United States of America
Analytical Contacts:
Nikola G. Swann
Toronto (1) 416-507-2582
John Chambers
New York (1) 212-438-7344
David T. Beers
London (44) 20-7176-7101

Transcript Of Standard & Poor’s Teleconference Held On Aug. 8, 2011
United States of America Long-Term Rating
Lowered To ‘AA+’, Outlook Negative
On Aug. 5, 2011, Standard & Poor’s Ratings Services lowered its longterm
sovereign credit rating on the United States of America to ‘AA+’
from ‘AAA’ and affirmed the ‘A-1+’ short-term rating. Standard &
Poor’s also removed the short- and long-term ratings from CreditWatch,
where they were placed with negative implications on July 14, 2011. On
Aug. 8, we held a teleconference at which market participants could ask
questions about, among other things, key reasons for the downgrade, factors
behind the negative outlook, and what it would take for the U.S. to regain its
‘AAA’ rating. (See the full report, “United States of America Long-Term
Rating Lowered To ‘AA+’ On Political Risks And Rising Debt Burden;
Outlook Negative,” published Aug. 5, 2011, on RatingsDirect on the Global
Credit Portal and our webpage, www.standardandpoors.com.)
Standard & Poor’s CreditWeek | August 17, 2011 7

features special report
The teleconference speakers were David
Beers, global head of sovereign ratings and
managing director; and John Chambers,
managing director and chairman of the
sovereign ratings committee. Bruce
Schachne, vice-president and head of
market development for Standard & Poor’s
in New York moderated the conference call
and asked questions, which had been submitted
by listeners, of the speakers. Here’s
an edited transcript of their comments and
their answers to questions from callers.
There were two things that we should focus
on…The first is the political settings…
The second issue is the fiscal position itself.
8 www.creditweek.com
David Beers: We’re going to be talking
primarily about our decision last Friday
to lower the U.S. government’s rating
from ‘AAA’ to ‘AA+’ with the negative
outlook but we’ll also, in response to
your questions, touch on a variety of
related issues around this action. My
colleague, John Chambers, is going to
briefly walk you through the key
aspects that led to the downgrade of the
U.S. government on Friday.
John Chambers: There were two things
that we should focus on, both of which
are important parts of our criteria. The
first is the political settings. Although we
think the political settings are still
strong, they’re not as strong as some of
our most highly rated governments.
We think the debate about the raising
of the debt ceiling is one illustration of
that, and perhaps more profoundly, we
think that elected officials across the
political spectrum are unable to proactively
take measures to put U.S. public
finances on a sustainable footing in the
same sort of manner as some of our
most highly rated governments.
The second issue is the fiscal position
itself. Right now, the net general government
debt to GDP—if you take the
broad measure of general government
debt—is just under 75% of GDP.
Almost under any scenario, that debt
burden is going to rise, and it’s going to
put pressure on the accounts.
If you don’t get reform on entitlement
spending more broadly, it’s going to put
the United States in a position that will no
longer, again, be comparable with most
highly rated governments that we have.
So those two items, the fiscal side and the
political side, led to the downgrade.
The other elements of the five
remaining credit strengths, the U.S.
economy, the monetary settings, and if
you take into account the dollar, which
will remain, we believe, the key international
currency, the external position.
Beers: John was talking about what he
likes to call the five pillars of our analysis
of all sovereign ratings. As most of you
know, we rate 126 sovereign governments.
The five pillars are political risk, economic
risk, external risk, debt and fiscal risk, and
lastly monetary policy risk. As we noted
on Friday, we, broadly speaking, view
three of them as unchanged. So the focus
of our action on Friday was around what
we take to be a more uncertain political
environment in the United States, as we
think was highlighted by the whole debt
ceiling debate this year and the continued
rising U.S. government debt burden even
with the fiscal agreement that Congress
and the President came to last week.
We updated our sovereign ratings
methodology earlier this year, which was
published on June 30 and is available on
our public website. (See “Sovereign
Government Rating Methodology And
Assumptions,” published June 30, 2011.) I
encourage those of you who haven’t looked
at it to take a look at it because, as with all
of our methodologies that we’ve been
updating in recent years, our objective is to
make it as transparent as possible, and that
means that you can actually go through
each of the categories of our ratings
methodology for sovereign results. You can
score them and then look at a table, which
has what the indicative ratings look like
based upon the scores that you provide.
So whether you agree with our opinion,
it gives you a basis to understand how we
got to that opinion and a basis for you to
decide whether you agree with it or not.

Bruce Schachne: One of the questions
that has been raised, publicly as well as by
some of our callers, is the question about
the baseline assumption Standard & Poor’s
used to arrive at the rating decision. Could
you tell us specifically which assumptions
were used and what those assumptions
mean for our expected debt to GDP ratios?
Beers: If you look at the Friday release,
we have a baseline—base case set of
assumptions—and then we have an upside
set of assumptions which are associated
with a possible stable outlook as opposed
to the negative outlook that we have on
the ‘AA+’ rating now. And we have a
downside scenario, which would be associated
with a further downgrade to ‘AA’.
Just to be clear, we use the concept of
net general government debt in our projections.
Remember, the concept of general
government debt consolidates federal,
state, and local governments.
What’s netted out is certain financial
assets that those governments hold. So this
year, we’re estimating net general government
debt will amount to about 74% of
GDP and our base case scenario projects
that by 2011 that debt burden will rise to
79% in 2015 and 85% by 2021.
Just to give you some flavor of what
these numbers look like in real money, this
year we’re projecting that net general government
debt will amount to something
just above $11 trillion. We think that that
will rise to $14.5 trillion by 2015, and at
2021, we’d reach just over $20 trillion. So
that’s our base case assumption on the
increase in net general government debt.
In our upside scenario, we incorporate,
in addition to the fiscal measures agreed
last week, the assumption of possible new
revenues of the order of $950 billion from
2013 onward on the assumption that the
2001 and 2003 tax cuts, as they affect high
earners, would lapse.
Under that scenario, and without additional
revenue, we project that net general
government debt as a percentage of GDP
would increase, again, from 74% this year
to 77% by 2015, and then 78% by 2021.
So it’s still a rising debt burden but a rather
flatter trajectory, which we think, other
things being equal, would be consistent
with a ‘AA+’ rating and stable outlook.
Lastly, under the downside risk scenarios,
we assume a couple of things.
One is a slower path of economic growth
than the two other scenarios I just mentioned.
Secondly, a bit higher path of
interest rates on U.S. government bonds
relative to the base cases. We also assume
that the agreement announced last week
between Congress and the administration
is not completely implemented. Taking
all that into account, we’d project that
the net public debt burden would rise
from 74% of GDP this year to 90% in
2015 and then to 101% by 2021. So that
gives you a flavor of some of the assumptions
that we’re working with.
Schachne: Some questions have been
raised on S&P’s original assumptions
on discretionary spending growth and
the revised assumptions that were used
in the published rating action. Could
you address those questions?
Chambers: It boils down to two different
baselines that are provided by the
Congressional Budget Office. One is a baseline
that assumes that current law remains
in place and things like the 2001 and 2003
tax cuts lapse as they’re scheduled to do
next year, that the AMT fully takes effect so
that wage earners of $100,000 or more
are captured in that net, that the clawback
of Medicare payments to doctors takes
effect every year. And that has outcomes
for what your spending looks like.
The CBO occasionally puts out an alternative
fiscal scenario which relaxes some of
these assumptions. The CBO scored the
Congressional Budget Act against the standard
baseline. We first ran our figures
against the alternative baseline. We discussed
with the Treasury which would be
most consistent or appropriate. We changed
our baseline on Friday to use the baseline
that keeps current law figures in place and
then we adjusted our numbers accordingly.
To give you an idea of the effect of that,
if you look to 2015, the total debt to GDP
under the alternative fiscal scenario would
be about 80.9% of GDP, under the existing
law baseline scenario, it’s 79% of GDP. If
you like to have numbers instead of ratios,
it’s $14.5 trillion with the new numbers
and $14.7 trillion under the old numbers.
Standard & Poor’s CreditWeek | August 17, 2011 9

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We don’t think that this change is the
trend. We don’t see under anything but
the most optimistic forecast that the debt
to GDP ratio of the United States government
at the general government level will
stabilize in the forecast horizon.
Schachne: On Friday, we also announced
that the outlook remains negative for the
U.S. rating. Could you tell us the reasons
why the outlook remains negative and
what factors might affect that negative
outlook going forward?
Chambers: An outlook speaks to a timeframe
of 6 to 24 months, and it’s telling
you that there is downward pressure on
the rating, there is upward pressure on the
rating, or is it balanced. And for the rating
to fall again, I think that you would need
greater fiscal slippage than what we currently
anticipate. And where could that
fiscal slippage come from? Well, it could
come if the new bicameral select committee
doesn’t come up with the cuts and,
for whatever reason, the sequestered ration
mechanism isn’t put into place. That could
be one example, you could think of others.
We don’t see anything immediately on the
horizon that would make an upgrade back
to ‘AAA’ the most likely scenario.
10 www.creditweek.com
Schachne: The question has been raised as
to what would it take for the U.S. to get
back to ‘AAA’ and other examples of sovereigns
that have been downgraded from
‘AAA’ and then were returned to ‘AAA’?
Beers: Mindful of the committee’s decision
and John’s remarks about the negative outlook,
let me highlight a couple of things.
First of all, we still think that the risk to the
rating is still pitched to the downside, that’s
why we have a negative outlook.
So we don’t anticipate a scenario at the
moment in which the U.S. would quickly
return to ‘AAA’. But if it did, consistent
with our criteria and what we said on
Friday, we suppose it would be because
of two interrelated factors.
The first is, in the context of what we
have seen around the fiscal policy debate,
I want to underscore the extraordinary
difficulty that people are having in finding
common ground around fiscal policy
choices and about how to bring the deficit
down convincingly over the medium
term. If that changed and there was a
broader consensus among parties about
how to make the fiscal policy choices over
the medium term horizon, and in turn
that translated into a more substantial
and more robust fiscal stabilization
package, those two things together in
time could lead to the ratings returning
back to ‘AAA’.
Given the nature of the debate currently
in the country and the polarization
of views around fiscal policy right now,
we don’t see anything immediately on the
horizon that would make an upgrade
back to ‘AAA’ the most likely scenario. I’ll
let John talk about the history of what’s
happened to some other sovereigns that
have lost their ‘AAA’ ratings.
Chambers: We’ll talk about those that got
it back, not the ones who didn’t get it back.
Five sovereigns have regained their ‘AAA’
rating: Canada, Australia, Finland,
Sweden, and Denmark. And they all did it
by undertaking over a sustained period of
time a substantial fiscal consolidation program.
They not only stabilized the debt as a
share of the economy but also markedly
reduced the debt as a share of the economy.
All of them, with the exception of
Australia, also undertook profound economic
reform that markedly improved
their external position. Now we haven’t
talked too much about the external position
of the U.S., we can talk more about
that, but I think the takeaway point is that
it wasn’t only a matter of fiscal reform. It
was also a matter of economic reform.
Now how long did it take for that to
happen? The one that did it most quickly
took 9 years, the one that took the longest
time was 18 years.
Beers: We should underscore a couple of
other points on this question. Each rating

has to be looked at in its own right.
Remember, we’ve got 126 sovereign ratings
and the ‘AAA’ subset is a relatively
small one. So each country, or sovereign,
has its unique characteristics. We’re not
suggesting any particular timeline to the
U.S. about when or how, under what circumstances
they might get back to ‘AAA’.
This just gives you some historical guidance
about what’s happened before.
I also want to make an additional
point about the sovereigns that John just
talked about. There were a number of
Scandinavian sovereigns on his list, and all
of them lost their ‘AAA’ ratings as a result
of the direct and indirect consequences of
their own banking crisis that they had in
the early 1990s. The direct consequence, of
course, was a hit to growth rates, severe
recessions, and relatively sluggish economic
recoveries in the beginning, also some indirect
as well as direct fiscal costs in terms of
recapitalizing their banking sectors. Of
course, we still are going through a stressful
period around the world after the great
recession that we had a couple of years ago.
These are still very pertinent sort of
issues for a number of sovereigns—that
is, the fiscal contingent liabilities and
support of the banking systems. These
are the sort of factors, thinking more
broadly about sovereign ratings, that
are key parts of our rating methodology
that we collaborate very closely in
looking at, particularly with our colleagues
on the financial institution side,
and may well be relevant factors for our
sovereign rating actions going forward.
Schachne: The most frequent question
submitted has been about the effect of
this move on other asset classes.
Obviously, Standard & Poor’s can’t comment
about rating actions that haven’t
taken place yet, but we did publish on
July 21 a scenario analysis looking at the
effect that this type of action might have
or the so-called ripple effect. Could we
hear some comments about specific asset
classes such as munis and agencies?
Beers: Yes, our comments on July 21 followed
our earlier CreditWatch action on
the U.S. We talked very broadly about a
number of scenarios and very broadly
about possible effects, depending on what
happened to the U.S.’s rating. (See “Most
Corporate Borrowers Remain Unaffected
By The U.S. Debt Debate—For Now,”
“The Implications Of The U.S. Debt
Ceiling Standoff For Global Financial
Institutions,” “Where U.S. Public Finance
Ratings Could Head In The Wake Of
The Federal Fiscal Crisis,” and “What If
Analysis: The Potential Impact To
Structured Finance Securities Of The U.S.
Debt Ceiling Standoff” published July 21,
2011.) So I want to mention very briefly
in an illustrative way some of the asset
classes that we highlighted then where I
expect in due course we will put out the
releases, because it wouldn’t be appropriate
otherwise for me to preannounce
rating actions that we haven’t taken yet.
Back on July 21, we highlighted the
GSEs (government sponsored enterprises).
We also highlighted some ‘AAA’ rated
insurance groups, and I think we talked
about some of the clearinghouses as well as
key sectors that we were looking at. As far
as public finance is concerned, other than
some particular transactions that are
directly linked to the U.S. government we
said we would be looking carefully at some
of the indirect effects on possible fiscal consolidation
programs in Washington as they
might affect the budgetary positions of
state and local governments.
We have to leave it there. We are
expecting an announcement on the linkages
and any rating actions associated
with that shortly.
Schachne: Could you comment on the
current and future role of the U.S.
dollar and how that relates to the
downgrade that happened on Friday?
Chambers: It had no role in the downgrade.
We think the dollar will remain the
key international reserve currency under
any plausible scenario. If you look at the
history of this—Barry Eichengreen and
others have written extensively about it—
you can have an economy that’s weakening,
but for not only network effects, but
also for lack of alternatives, the currency
retains its reserve currency status. If for no
other reason than this, we expect the dollar
to retain its position. That is going to result
Standard & Poor’s CreditWeek | August 17, 2011 11

features special report
12 www.creditweek.com
in lower financing cost than otherwise
would be the case, not only for the government,
but also for the private sector.
You really only have two competitors in
the race. One is the dollar and the other is
the euro. Because you need to have an
internationally traded currency, you need
to have a deep capital market, you need to
have a strong banking system. The U.S.
economy has its own problems that we’ve
highlighted with our downgrade, but the
Euro area has its issues as well.
Schachne: There’ve been a number of
questions about our views of some of the
key European sovereigns, and specific
questions about countries like France and
the U.K. which still are rated ‘AAA’. Can
you comment on some of our outlooks
for those countries?
In France’s case, we expect that the debt
burden has probably peaked and should
begin to decline slightly going forward.
Chambers: I’ll say something about
France, where I used to live. And I’ll let
David say something about the U.K.,
where he lives now. Some of the fiscal indicators
today of France are actually slightly
worse than the U.S., particularly if you
look at the debt position, not the deficit
position. But one of the steps that France
took last year, or earlier this year, was
enacting a pension reform that raised the
retirement age statutorily by two years and
effectively by a bit more because it took
steps to discourage early retirement.
Although that doesn’t change the
deficit outturn for this year or next, it
markedly improves the intertemporal
solvency of the state. It markedly lowers
your future entitlement spending. That
was a clever step in a couple of ways.
One of them was the government stuck
to its guns. It got a lot of pushback from the
street. But it didn’t cave in to that pressure.
Which I think underscored the government’s
credibility to take difficult measures.
And, secondly, it was a fiscal measure
that reinforced market confidence in the
ability of policymakers to take proactive
steps to address the medium-term fiscal
sustainability of public finances. But it
didn’t immediately withdraw fiscal stimulus
from the economy. That is an
example of well-designed fiscal policy.
Beers: Just a couple of other additional
points on France. It’s true that the
French—as a number of other “AAA”
governments—provided a fiscal stimulus
a few years ago. But that happened fiscally
even above and beyond the pension
reform that John was just discussing. And
they’ve been doing it through a combination
of revenue measures, essentially
closing various tax concessions and also
spending measures. So, they, in fact, have
started fiscal consolidation since last year.
And that’s why, unlike the U.S., as we
noted before, where even with the fiscal
consolidation plan adopted last week
we expect the net public debt burden of
U.S. government to continue to rise
over the medium to longer term. In
France’s case, we expect that the debt
burden has probably peaked and should
begin to decline slightly going forward.
Turning to the U.K., we assigned a
negative outlook to the U.K.’s ‘AAA’
rating back two years ago. We changed
that outlook back to stable last October.
This occurred after the Coalition
Government took office in the U.K.’s
general election of May of last year. They
started to implement a very comprehensive
fiscal stabilization program last year,
and they’re continuing to implement it
this year and going forward. Again, we
expect the debt burden to peak out in the
next couple of years and then begin to
decline. Notwithstanding the fact that
the U.K. is struggling with its own economic
recovery, we’re pretty confident
that the Coalition’s going to hold in the
U.K., and that they’re going to implement
its fiscal strategy with fairly modest
changes. We think politics are going to
keep the two Coalition partners together
until the next general election.
In Germany’s case, they had a mild
fiscal stimulus and their starting fiscal
position was pretty good. They’ve

already taken steps to begin to run their
fiscal stimulus. So, again, we expect basically
a scenario as with the other ‘AAA’
sovereigns that we’ve been talking about.
Our basic answer to that scenario is we
expect their debt burden to begin to
decline, again, in contrast to the U.S.
where we expect the debt burden to continue
to grow.
Of course, there’s Canada to the north
of the U.S. Thanks to a sustained program
of fiscal consolidation in the
1990s, the debt burden in Canada is very
low, comparatively, at around 30% of
GDP or so. Their recently elected
majority government has been visibly
rolling back the mild fiscal stimulus
which they had and is aiming to get their
budget back in balance. We think that
they’re likely to succeed in that objective.
So the debt burden is low, and we think
it’s on a declining trend.
Schachne: Moving to some of the other
sovereigns we rate in emerging markets, do
we think that this downgrade action will
have any effect on the emerging markets?
Chambers: I don’t think it’s going to have
a direct knock-on effect. Remember, this
downgrade is going from ‘AAA’ to ‘AA+’.
We have about 20 ratings between ‘AAA’
and ‘D’ (for default). So, going from your
highest rating to your next-highest
rating—symbolically it’s important, of
course—but it’s like going from indigo to
navy blue.
As far as knock-on effects for the
emerging markets, many of these markets—because
of fundamental reforms
that they took on early in the decade—
have kept their fiscal house in order. Their
external position, for a variety of reasons,
is much stronger now than it used to be.
Many of them are benefitting from
favorable terms of trade, which is not a
ratings factor because that changes over
time. But many of them are in better
shape. You’d have to go through one by
one, though, to have a nuanced appraisal.
Beers: One other point to underscore,
coming back to a comment I made earlier,
is that there are a number of key
factors that we have to look at for all of
our sovereigns with emerging markets
and more advanced ones going forward.
I’ve highlighted this kind of tricky
patch we’re experiencing in terms of the
global growth outlook. We’re in the
highly unusual position where there are a
lot of questions about the growth outlook
of the U.S., as well as a lot of questions
about the growth outlook in the
European Union. And while Japan is
beginning to bounce back nicely from the
nuclear disaster that they had earlier this
year, they still have a slowing trend
growing rate in terms of GDP. So this is a
large chunk of the global economy.
Emerging markets—most notably
China—have been filling much of that
demand, which is not coming from the
events, countries, and regions I talked
about before. But the economic prospects
of many emerging market sovereigns are
still very dependent on global trade patterns.
So the future growth trajectory of
China and the prospects for some of the
advanced economies are very important
in terms of how they’re going to fare over
the next couple of years.
So all this is in the mix. And all this
has to be looked at individually as well
as the policy responses of these governments
to any of the headwinds that they
faced in terms of how they interact with
the global economy.
Schachne: There’s a question about the
concept of forced selling. So, now that
the U.S. has been downgraded from
‘AAA’, do we believe that this will force
investors to sell Treasuries or other
securities?
Chambers: When we talk to investors—
and David and I speak to lots and lots of
investors—we ask them this question.
What most of them say is if there are
guidelines regarding that, there won’t be
any selling before there’s a discussion
with the individual investor. And they
think that there will be very little forced
selling today.
Schachne: David, you spoke earlier
about the ripple effect on munis and
agencies. Is there a sovereign ceiling that
pertains to corporate ratings in the U.S.?
Standard & Poor’s CreditWeek | August 17, 2011 13

features special report
Beers: We haven’t been using the term
sovereign ceiling for many, many
years—going back to the mid-90s or
even before. So, as a practical matter in
the U.S. and pretty much everywhere
else in the globe, the sovereign rating
doesn’t necessarily cap the ratings of
other issuers.
There are lots of reasons why we
think it’s appropriate to think about
these issues—particularly the knockon
effects—in a more nuanced fashion.
But back in July, in the release that we
put out on the 21st of July, we commented
that overall in the corporate
sector we thought that the effect of
this—of what had been a hypothetical
and now is an actual—one-notch
downgrade of the U.S. government
was probably going to have the minimalist
effect. That’s because there isn’t
a sovereign ceiling in the U.S. or any
of the other countries that we rate.
There can be indirect effects. They will
all be analyzed. But overall, the corporate
analysts opine that that sector
would probably be the least affected
sector of the ones that we were talking
about earlier.
This isn’t a view of S&P, this is a view
of the IMF. The sovereign ratings are a
very robust indicator of credit risk.
14 www.creditweek.com
Schachne: John Chambers, you
referred earlier to past history, about
sovereigns that were downgraded and
got their ‘AAA’ back. Can you talk a
little more about sovereign rating history:
how we’ve tracked it, and how
we’ve tracked and measured performance
of sovereign ratings?
Chambers: Well Bruce, we publish a
recap of that every year. After the repeal
of the Interest and Equalization Tax,
sovereigns began to issue in the U.S.
market again. And sovereign ratings
began to take off from that point,
which is 1975. And the number of ratings
has grown since then.
So we’re talking about nearly 40
years of data. We talk about a 15-year
cumulative default rate; that’s the
longest horizon that we have robust statistics
for over that 40-year horizon.
We’ve never had a ‘AAA’, a ‘AA’, or a
‘A’ default. Overall, investment grade
defaults over the 15-year horizon are
something like 1%. And speculative
grade defaults are, like, 30%.
So, there are two things I want to
highlight. One is that the rank
ordering of our ratings is very robust.
You can see that in our GINI data.
The second is that over a 15-year
period, we’ve never had a sovereign
default that was rated ‘A’, ‘AA’, or
‘AAA’. Now with Greece, we might
get one count. The highest Greece
was ever rated was in the ‘A’ category.
But we’re very proud of our record
and we think it speaks to the strength
of our analytics.
Beers: It’s worth highlighting that the
International Monetary Fund—going back
to the days of the Asian Financial Crisis
over a decade ago—has published a
number of reports about sovereign credit
ratings, including ours. They have repeated
the very points that John was underscoring.
(Please copy and paste the following URL
into your browser to access the report:
http://www.imf.org/external/pubs/ft/gfsr/20
10/02/pdf/text.pdf) This isn’t a view of
S&P, this is a view of the IMF. The sovereign
ratings are a very robust indicator
of credit risk.
Rating actions and also, importantly,
our outlooks and CreditWatch indicators
are useful information to the marketplace.
And they’ve also highlighted
the fact, for example, that no sovereign
that defaulted had an investment-grade
rating at least a year or more before it
defaulted. And so on.
So I think most independent observers
who look at our ratings and look at our
methodology understand that the ratings
that we have are robust, and certainly
ahead of the group. And having a very
large and capable team behind John and

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me, we’re very committed to ensuring that
the track record continues.
Schachne: Alan Greenspan said that
there’s a 0% of the U.S. default on government
debt because the U.S. can
always print money. If the U.S. tries to
inflate away its debt, would S&P see
that as default by another name?
Beers: That’s a great question. I think it
comes up a lot and reflects a somewhat
oversimplified view of credit risk. Let
me illustrate that in a couple of ways. A
couple years ago, Zimbabwe, which we
don’t rate, had one of the world
records, probably the fourth-highest
hyper-inflation in history. As far as we
can understand, they did default on
some of their foreign currency obligations
over the years.
But the idea that very high rates of
inflation can somehow reduce the
burden of government debt that is associated
with high creditworthiness is
something that no reasonable person in
the world would—and S&P’s methodology
just can’t—comprehend. Then
there’s also a practical point. The U.S.
government, like a lot of governments
in the world, issues inflation-projected
or inflation-linked debt.
So the U.S. government today on a
significant and possibly growing proportion
of its own obligations—alongside a
large number of other governments that
we rate around the world—not only is
promising on its nominal debt to pay
interest and principle on time and in
full, but also with inflation-projected
debt its making an extra promise, which
is to protect the value of that debt
against changes in prices.
So for those governments that have a
significant and growing portion of inflation-linked
debt, they’ve already given
up the inflation weapon. If they wanted
to reduce the real value of that debt,
they’d have to default on inflationlinked
bonds.
By the way, there are historical examples
of this. Brazil—investment-grade
sovereign that it is today—is just one
example of historically going back to
the 1980s and the 1990s that actually
reneged in part on inflation-linked debt
at that time. They did so by reducing,
retrospectively, the real coupon on that
inflation-linked debt.
So, printing money doesn’t deliver a
‘AAA’ rating. And there’s another more
subtle point to make about high and
volatile rates of inflation, which is the
insidious effect that high and volatile
rates of inflation have on your social and
political institutions, and also on your
economic performance, which of course,
feeds back into your fiscal performance.
And that’s why we’ve also seen examples
historically of sovereigns restructuring
their local currency debt (which
they issue with their own currency) with
their own central bank because after all
of the insidious effects of inflation they
try a variety of conventional and unconventional
ways to get out of it.
But one of the unconventional ways
to get out of this treadmill of high inflation
is to restructure your debt. So even
with the printing press of a central
bank, it doesn’t necessarily save you
from debt restructuring. That’s the
record of history.
Chambers: I would just add as a footnote
that the U.S. government, under
existing criteria at least, defaulted on its
debt in 1933 when Roosevelt abrogated
the gold clauses on U.S. debt.
Schachne: Well David Beers, John
Chambers, thank you very much for providing
more insight and transparency into
the downgrade announcement on the U.S.
rating. As David mentioned earlier, we
will be publishing further details on the
ripple effect and how it might affect specific
securities, which will be posted on
www.standardandpoors.com. CW
For more articles on this topic search RatingsDirect with keyword:
United States of America
Analytical Contacts:
David T. Beers
London (44) 20-7176-7101
John Chambers, CFA
New York (1) 212-438-7344
Nikola G. Swann, CFA, FRM
Toronto (1) 416-507-2582
Standard & Poor’s CreditWeek | August 17, 2011 16

features special report
17 www.creditweek.com

U.S. Sovereign Rating Downgrade Has
Knock-On Effects For Some Borrowers
In light of Standard & Poor’s Ratings Services’
downgrade of the rating on the United States of
America, we have lowered the ratings on a number of
entities and debt issues whose creditworthiness is directly
or indirectly linked to, or heavily dependent on, the
credit quality of the sovereign. (See “U.S. Long-Term
Rating Lowered To ‘AA+’; Outlook Negative,” on p. 3.)
While we don’t view sovereign ratings
as ceilings for other entities, sovereign
credit risk is a key consideration in our
assessment of nonsovereign ratings
because the wide-ranging powers and
resources of a national government can
affect the financial, operating, and
investment environments of entities
under its jurisdiction. Standard &
Poor’s issuance of a rating higher than
the sovereign reflects our view of an
entity’s willingness and ability to pay its
debt as superior to that of the sovereign.
Moreover, it reflects our view that
if the sovereign does default, there is an
appreciable likelihood that the entity or
its debt won’t follow suit. (See
“Understanding Ratings Above The
Sovereign,” on p. 22.)
History shows that a sovereign default
can directly result in defaults by related
borrowers, as can the deterioration in the
economic and operating environment that
is typically associated with a sovereign
default. Therefore, our lowering of the
U.S. sovereign rating to ‘AA+’ from ‘AAA’
has had a number of knock-on effects.
Government-Related Enterprises
Government-related enterprises (GREs)
are entities often partially or totally controlled
by a government (or governments),
and they contribute to implementing policies
or delivering services to a country’s
population. A GRE’s rating usually falls
between its stand-alone credit profile and
the respective government’s rating, and we
assess the likelihood of sufficient extraor-
Standard & Poor’s CreditWeek | August 17, 2011 18

features special report
dinary government intervention to help
the GRE meet its financial obligations.
Following our downgrade of the U.S.,
we lowered our senior issue ratings on
Fannie Mae and Freddie Mac to ‘AA+’
from ‘AAA’, reflecting their direct
reliance on the U.S. government after
the mortgage lenders were placed into
conservatorship in September 2008.
Meanwhile, we lowered our issuer
credit ratings and related issue ratings on
the Farm Credit System and 10 of 12
Federal Home Loan Banks (FHLBs)—as
well as the senior debt issued by the
FHLB System—to ‘AA+’ from ‘AAA’. We
see the Farm Credit System as having a
very high likelihood of receiving support,
if needed, from the federal government
and consequently its rating reflects one
notch of uplift from its ‘aa’ stand-alone
credit profile. Similarly, the FHLB banks
have either ‘aa+’ or ‘aa’ stand-alone credit
profiles and we also view them as having
a very high likelihood of receiving support.
We view the FHLB System as almost
certain to receive government support, if
necessary, and we therefore rate its debt
at the same level as the U.S. sovereign.
We also lowered our ratings on 126
Federal Deposit Insurance Corp.-guaranteed
debt issues from 30 financial institutions
under the Temporary Liquidity
Guarantee Program (TLGP), and four
National Credit Union Association-guaranteed
issues from two corporate credit
unions under the Temporary Corporate
Credit Union Guarantee Program
(TCCUGP) to ‘AA+’ from ‘AAA’. The
downgrades on the TLGP and TCCUGP
issues reflect their direct credit support
from the U.S. Treasury.
In addition, we lowered our corporate
credit ratings on Army & Air Force
Exchange Service (AAFES), Marine Corps
19 www.creditweek.com
Community Services (MCCS), and Navy
Exchange Service Command (NEXCOM)
to ‘AA-’ from ‘AA’, and affirmed our
‘A-1+’ short-term ratings on the three
GREs. We removed all the ratings from
CreditWatch negative. The outlook on
AAFES is stable, while the outlooks on
MCCS and NEXCOM are negative.
The downgrades reflect the interplay
between the sovereign rating and the entities’
stand-alone credit profiles. The ratings
continue to reflect our opinion that
there is a very high likelihood the U.S.
government would provide timely and
sufficient extraordinary support to these
entities in the event of financial distress.
In addition, Standard & Poor’s lowered
its long-term rating on Tennessee
Valley Authority (TVA) to ‘AA+’ from
‘AAA’, reflecting the interplay between
We have observed that some state or local
governments have more favorable balances
between resources and responsibilities than
the federal government.
the sovereign rating and TVA’s ‘aa-’
stand-alone credit profile. We believe that
there is an extremely high likelihood that
this corporation, which is wholly owned
by the U.S. government, would receive
extraordinary federal support in the
event of financial distress and, therefore,
reflect a two-notch uplift in its rating.
We also lowered our ratings on Energy
Northwest (ENW), Wash.’s revenue
bonds and on several nonfederal debt
obligations that the Bonneville Power
Administration (BPA), Ore., pays as
operating expenses of its electric system,
to ‘AA-’ from ‘AA’. The outlook is
stable. The rating action reflects the
interplay between our U.S. sovereign
rating and BPA’s ‘aa-’ stand-alone credit
profile. We believe that there is a moderately
high likelihood that the U.S. government
would provide extraordinary
support to BPA, and therefore no uplift
is warranted at this rating level. The
stable outlook reflects our view that
BPA’s stand-alone credit profile could
withstand the possibility of further negative
actions on the U.S. government’s ratings,
if such actions were to occur.
Public Finance Debt
After the downgrade of the U.S. sovereign
rating, and subsequent downgrades of
Fannie Mae and Freddie Mac, we lowered
our ratings on certain public finance
debt issues that have credit enhancement
guaranteed by Fannie Mae and Freddie
Mac, to ‘AA+/A-1+’ from ‘AAA/A-1+’.
The ratings on the debt are linked to
the ratings on Fannie Mae or Freddie
Mac, which either guarantee direct payments
on the bonds, or in some circumstances,
guarantee mortgage payments
in the event of a mortgage default. In
the case of the affected issues, the guarantee
is irrevocable and is in place until
the bonds’ maturities.
Similarly, we lowered to ‘AA+’ from
‘AAA’ our ratings on certain public finance
debt issues that have credit enhancement
guarantees by Ginnie Mae in the form of
mortgage-backed securities (MBS). The ratings
on those issues reflect our view of the
support likely to be provided by the U.S.
government. Payment on the MBS
enhancements backed by Ginnie Mae is
backed by the full faith and credit of the
government, and the ratings on those issues
reflect the rating of the U.S. government.
We also lowered our ratings on certain
public finance housing authority issuer
credit ratings following the downgrade of
the U.S., because we believe there is a
moderate likelihood that public housing
authorities would benefit from government
support in the event of an extraordinary
circumstance. In our view, the lower
U.S. sovereign rating no longer supports a
one-notch uplift from the stand-alone
credit profile of the affected ratings.
We also placed certain public finance
debt issues that have mortgage guarantees
from the Federal Housing
Administration (FHA) on CreditWatch
with negative implications following the
U.S. downgrade. FHA guarantees cover
nearly all the losses from loans that have
defaulted, with the FHA assuming the
risk of recouping its expenses through the
sale of the foreclosed property. The

issuer, through the loan servicer, receives
the claim from the FHA for the balance
of the loan and other expenses, but has
no claim to the sale proceeds—and so in
the foreclosure process on an FHA loan,
the issuer’s entire exposure is exclusively
to the FHA.
Meanwhile, Standard & Poor’s lowered
its ratings to ‘AA+’ from ‘AAA’ on a
number of bonds backed by federal leases
following the downgrade of the U.S. The
lower ratings on the bonds reflect our
view that the lease rental payments supporting
the various bonds, while subject
to appropriation, are backed by the full
faith and credit of the U.S.
We also lowered our ratings on
defeased bonds secured by U.S.
Treasury and U.S. agency securities to
‘AA+’ from ‘AAA’. In addition, we lowered
the ratings on several defeased
industrial revenue bonds to ‘AA+’ from
‘AAA’ because these bonds rely on
investments in U.S. Treasury or agency
securities for debt repayment.
States and local governments
Given the actions mentioned earlier, it’s
important to note that the ratings on
state, regional, or local governments
can be higher than the sovereign rating
if, in Standard & Poor’s opinion, the
individual credit characteristics of those
governments will remain stronger than
those of the sovereign during times of
economic or political stress.
A minority of these entities are rated
‘AAA’, based on what we consider to be
particularly strong credit characteristics.
Beyond analyzing economies in isolation,
we have observed that some state or local
governments have more favorable balances
between resources and responsibilities
(i.e., they may be less leveraged) than
the federal government. We believe that
certain state and local governments have
historically shown a greater commitment
to fiscal discipline or a more resilient local
economy, which may be reflected in ratings
higher than that of the U.S. government.
However, in light of the potential
for common economic and credit environments
among the U.S. and state and local
governments, we expect that in most
instances in which states and municipali-
ties have ratings above that of the U.S., the
differential will be limited to one notch.
Banks And Insurers
Banks rarely have ratings above the sovereign,
given that the industry is more likely
than any other to be directly, or indirectly,
affected by any sovereign default. This is
because of banks’ high leverage compared
with nonfinancial corporate borrowers,
the volatility of their assets and liabilities
in a crisis, their dependence on market
sentiment, and their typically large direct
exposure to their sovereigns.
Before the U.S. rating downgrade,
none of the banks we rate in the U.S.
had issuer credit ratings of ‘AAA’ or
‘AA+’. As such, our lowering of the U.S.
rating and outlook change to negative
had no immediate or direct effect on
our ratings on U.S. banks.
Similarly, we consider direct and indirect
sovereign risks—e.g., the effects of
economic volatility and investmentportfolio
deterioration—when we
assign ratings to insurers, and it would
be rare for a U.S. insurer that didn’t
benefit from external support to have a
rating above the sovereign.
In this light, Standard & Poor’s lowered
to ‘AA+’ from ‘AAA’ its long-term
counterparty credit and financial strength
ratings on the member companies of five
U.S. insurance groups: Knights of
Columbus, New York Life Group,
Northwestern Mutual Life Insurance Co.,
Teachers Insurance & Annuity Assoc. of
America (TIAA), and United Services
Automobile Assoc. (USAA). The outlooks
on the ratings on all of these companies
are negative. We also lowered our ratings
on about $17 billion of securities issued
by New York Life, Northwestern Mutual,
TIAA, USAA, and their affiliates.
At the same time, we affirmed our
‘AA+’ ratings on the members of five
other insurance groups: Assured
Guaranty, Berkshire Hathaway Insurance
Group, Guardian, Massachusetts Mutual
Life Insurance Co., and Western &
Southern Financial Group Inc. We also
revised our outlooks on these companies
to negative from stable.
While our assessment of these companies’
fundamental credit characteristics
Standard & Poor’s CreditWeek | August 17, 2011 20

features special report
21 www.creditweek.com
hasn’t changed, our ratings actions reflect
our view that the link between their ratings
and the credit quality of the sovereign
could lead to a decline in the
insurers’ financial strength. We base this
on the fact that the companies’ businesses
and assets are highly concentrated in the
U.S. and generally have significant holdings
of U.S. Treasury and agency securities.
For the insurers with the most exposure,
these investments constitute as much
as 200% of total adjusted capital at yearend
2010. We believe the 10 affected
groups have very strong financial profiles
and favorable business profiles to support
the ‘AA+’ ratings, and that they maintain
very strong capital and liquidity.
Clearinghouses
Standard & Poor’s lowered its longterm
counterparty credit ratings on The
Depository Trust Co., National
Securities Clearing Corp., Fixed Income
Clearing Corp., and Options Clearing
Corp. to ‘AA+’ from ‘AAA’.
The downgrades incorporate potential
incremental shifts in the economic
environment and the long-term stability
of the U.S. capital markets as a result of
the decline in the creditworthiness of
the federal government rather than any
change in our view of the fundamental
soundness of the companies’ depository
or clearing operations.
Funds
We also lowered our fund credit quality
ratings (FCQRs) on 73 funds of the 206
funds managed in the U.S., Europe, and
Bermuda. We lowered the fund ratings,
70 of which were ‘AAAf’, up to two
notches, depending on the funds’ longterm
exposure to the U.S. sovereign. At
the same time, we removed all 73 funds
from CreditWatch negative, and the
fund volatility ratings were unaffected.
FCQRs reflect our view of the level of
protection a fund provides against
losses from credit defaults, and address
a fund’s overall exposure to default risk.
We apply a set of credit factors for each
rating category and a set of credit scores
for each FCQR category, based on our
historical ratings stability and ratings
transition studies.
Structured Finance
Meanwhile, our ratings on 744 structured
finance transactions remain on
CreditWatch with negative implications
following the lowering of the sovereign
credit rating. We had placed the ratings
assigned to the securities on
CreditWatch negative due to potential
exposure to the U.S. rating, and we will
review the affected transactions, as well
as any additional transactions we
expect may be affected, and take rating
actions we view as appropriate. These
transactions have a link to the U.S. sovereign
rating due to various reasons,
including: transactions backed by U.S.
government obligations, including
defeased securities, and transactions
that benefit from full or partial government
guarantees.
We expect to lower the ratings on
most of the affected transactions to a
level no higher than the sovereign.
Nonfinancial Corporate
Borrowers
Generally, a change in the credit rating of
a sovereign issuer doesn’t necessarily lead
to a change in ratings or outlooks on similarly
rated nonfinancial corporate borrowers
in that country. A corporate borrower’s
ratings may exceed those on the
sovereign if we expect the company
would continue to fulfill its financial obligations,
even after a sovereign default.
Depending on an industry’s or individual
company’s financial strength, a borrower
may be well positioned to withstand economic
shocks or other country-related
risks. In this light, our downgrade of the
U.S. hasn’t affected our ratings or stable
outlooks on the four remaining U.S.based
‘AAA’ rated corporate issuers:
Automatic Data Processing Inc. (ADP),
ExxonMobil Corp., Johnson & Johnson,
and Microsoft Corp. CW
For more articles on this topic search RatingsDirect with keyword:
U.S. Sovereign Ratings
Analytical Contacts:
Curtis Moulton
New York (1) 212-438-2064
Laura Feinland Katz
New York (1) 212-438-7893

Credit FAQ
Understanding
Ratings Above
The Sovereign
The number of sovereign rating actions that Standard & Poor’s Ratings
Services has taken over the past several months has led to heightened
interest in our approach to issuing ratings that are above the
sovereign’s for government-related entities (GREs), banks, insurers,
corporations, state, regional, or local governments, and securitizations.
Investors have asked for clarification on our methodologies and examples of
how we put them into practice. So it seems appropriate to summarize the
criteria we’ve published on the topic and to answer the questions we receive
most frequently from market participants. We note that for entities
domiciled in countries which are members of the European Monetary Union
(EMU), readers should refer to the separate criteria article: “Nonsovereign
Ratings That Exceed EMU Sovereign Ratings,” published June 14, 2011,
on RatingsDirect, on the Global Credit Portal.
Standard & Poor’s CreditWeek | August 17, 2011 22

features special report | Q&A
Summary: Standard & Poor’s
Criteria, Ratings Above
The Sovereign
Sovereign credit risk is generally a key
consideration in our assessment of
nonsovereign ratings. This is because
the unique, wide-ranging powers and
resources of a national government can
affect the financial, operating, and
investment environments of entities
under its jurisdiction. Past experience
has shown that defaults by otherwisecreditworthy
borrowers can stem
directly from a sovereign default, or
indirectly from the deterioration in the
local macroeconomic and operating
environment that typically is associated
with a sovereign default.
While sovereign ratings are not “ceilings,”
in our view, Standard & Poor’s
does consider the impact of sovereign
risk as part of the rating process for
non-sovereign entities. When we issue a
rating for an entity that is higher than
the rating of its respective sovereign government,
Standard & Poor’s expresses
its view that the entity’s willingness and
ability to service its debt is superior to
that of the sovereign. Moreover, we are
offering the opinion that, ultimately, if
the sovereign does default, there is an
appreciable likelihood that the entity or
its debt will not default.
Issuers with a rating above the sovereign
have, in our view, sufficient operational
and financial flexibility to mitigate
sovereign and country risks, even
as those risks intensify. By “country”
risks, we mean those risks of an issuer
doing business in a particular country,
as distinguished from sovereign credit
risk, which refers to the risk of the sovereign
defaulting on its commercial
debt obligations.
Standard & Poor’s may rate a
nonsovereign entity or securitization
above the sovereign foreign currency
rating, depending on its operating and
financial characteristics, stress tested for
a sovereign default scenario.
We believe that issuers and transactions
are exposed to sovereign and country
risks to varying degrees. Our methodology
with respect to ratings proposed to
exceed those of the relevant sovereign
23 www.creditweek.com
considers these differences. We also consider
the extent to which an entity or
transaction is exposed to any single sovereign
government. Geographical diversification—doing
business in more than one
country—can therefore be a key mitigant
for sovereign related risks.
Typically, we view banks, and GREs
(see footnote and Frequently Asked
Questions, in this article), among the
entities most exposed to sovereign risk.
Among those we believe that are least
exposed to sovereign risk are corporations
with a robust export base (or offshore
operations or offshore parent
support), low reliance on the public
sector, products for which domestic
demand is relatively inelastic, and low
exposure to regulation.
Financial institutions
As we noted in “Sovereign Risk For
Financial Institutions,” published Feb. 16,
2004, banks rarely have a rating above the
sovereign: “Banking is more likely than
any other industry to be directly or indirectly
affected by any sovereign default or
other such crisis,” we wrote. “This vulnerability
is due to the extremely high
leverage of banks (compared to corporates),
the volatile valuation of their assets
and liabilities in a crisis, their dependence
on [market] confidence (which can disappear
in a crisis), and their typically large
direct exposure to their sovereigns. Bank
ratings, therefore, with few exceptions,
logically should not exceed those of their
sovereigns.” However, this may not apply
when a sovereign is in default (see
Frequently Asked Questions in this
article). Exceptions include cases where
there is external support (parent guarantees
or other strong forms of parent support),
offshore banks, and banks that
operate mainly outside their country of
domicile. Offshore banks are those headquartered
in certain countries, such as the
Cayman Islands, that encourage their
establishment and grant them special
licenses. The licenses usually exempt them
from certain domestic regulations and
taxes but do not allow them to do any (or
only very limited) domestic business.
Standard & Poor’s also considers several
country-specific risks related to
banks in our analysis of the Banking
Industry Country Risk Assessment
(please refer to “Banking Industry
Country Risk Assessments,” published
Aug. 8, 2011 (updated monthly), and
“Request For Comment: Methodology
For Determining Banking Industry
Country Risk Assessments,” published
May 13, 2010).
The strengths and weaknesses of an
economy and banking industry are critical
factors that underpin the credit profile
of a country’s financial institutions.
For that reason, to analyze the credit
standing of a financial institution,
Standard & Poor’s places it in the context
of the broad economic, regulatory, and
legal environment where it operates. We
distill this analysis into a single Banking
Industry Country Risk Assessment, or
BICRA, that reflects the strengths and
weakness of a country’s banking industry
relative to other countries.
Insurance
As we noted in “Factoring Country
Risk Into Insurer Financial Strength
Ratings,” published Feb. 11, 2003, we
consider direct and indirect sovereign
risks—such as the impact of macroeconomic
volatility, currency devaluation,
asset impairment, and investment portfolio
deterioration—when arriving at
insurer ratings.
As we further explained in that
article, it would be rare for a domestic
insurer that did not benefit from
external support to have a rating above
the sovereign local currency rating.
Sovereign stress has an overwhelming
impact on insurer creditworthiness
through both direct and indirect effects.
The direct impact of a sovereign local
currency default should weigh heavily
on companies with direct exposure to
sovereign local currency debt, as is
often the case for insurers that have a
significant liquidity position maintained
in government bonds. Standard &
Poor’s will not assign domestic insurers
a rating higher than the local currency
rating on the sovereign in which they
are domiciled, other than in demonstrated
cases of extraordinary financial
strength and other characteristics that

mitigate domestic risk factors. Only in
exceptional circumstances would the
rating on a company be higher than the
local currency rating on its home
country without explicit support. Such
would be the case if the local insurer
can be shown to have the wherewithal
to survive a comprehensive set of stress
case assumptions consistent with a sovereign
default scenario (e.g., government
bonds trading at a fraction of
their face value, highly depressed equity
valuations, or loan and bond assets
having migrated to highly speculative
levels if not defaulted).
Another exceptional circumstance
would be for insurers domiciled in certain
specified financial centers, such as
the Cayman Islands, Bermuda, or
Ireland. We would generally view such
insurers as independent of that financial
center’s sovereign risk. The same would
hold true if most of the insurer’s assets
were located outside of the jurisdiction of
domicile; in such case we have taken the
view that a sovereign collapse (related to
the domicile) would not likely impair the
financial strength of the insurer.
Public Finance
In “U.S. State Ratings Methodology,”
published Jan. 3, 2011, and “Rating A
Regional Or Local Government Higher
Than Its Sovereign,” published Sept. 9,
2009, we noted that the rating on a
state, regional, or local government can
be higher than the sovereign rating if, in
our view, the individual credit characteristics
of those governments will
remain stronger than those of the sovereign
in a scenario of economic or political
stress. We mentioned that “most
LRGs are not rated above the sovereign
because they are vulnerable to many of
the same factors that would prevent the
sovereign from taxing or borrowing to
the extent necessary to meet its obligations.
LRGs’ reliance on sovereign
transfers often compounds this vulnerability.”
Nevertheless, we noted conditions
under which we might rate a local
or regional government above its
respective sovereign:
■ In order to assign an LRG a local currency
rating above the sovereign’s
foreign or local currency rating,
Standard & Poor’s assesses whether it
believes there is a measurable likelihood
that the LRG’s credit characteristics
will remain stronger than those
of the sovereign in a scenario of economic
or political stress. In other
words, Standard & Poor’s considers
whether the structural differences and
the institutional features allowing the
LRG to be rated above the sovereign
are resilient to a major economic or
political disruption, and whether the
LRG would have sufficient flexibility
to mitigate negative intervention from
the government.
This concept translates into three fundamental
conditions. For Standard &
Poor’s to rate an LRG higher than its
sovereign, the LRG is expected to
exhibit the following:
■ The ability to maintain stronger
credit characteristics than the sovereign
in a stress scenario,
■ An institutional framework that is
predictable and that limits the risk of
negative sovereign intervention, and
■ The ability to mitigate negative intervention
from the sovereign thanks to
high financial flexibility and independent
treasury management.
In most cases where these three conditions
are met, we expect the ratings differential
between an LRG and its respective
sovereign to be limited to one notch.
Nonfinancial corporate sector
Ratings on a nonfinancial corporate borrower
may exceed those on the sovereign,
if we expect that the company
would continue to perform and fulfill its
financial obligations, even in a sovereign
default scenario. Depending on the
industry sector or the individual company’s
financial strength, a company
may be more or less able to withstand
macroeconomic shocks or other countryrelated
risks. In considering corporate
ratings vis-à-vis the sovereign rating, we
consider the exposure of a company to a
typical sovereign stress scenario. In the
past, such stresses have included: sharp
currency movements, credit shortages, a
weakened banking sector, higher government
taxes and fees, delays in payment
Standard & Poor’s CreditWeek | August 17, 2011 24

features special report | Q&A
from government customers, a more difficult
regulatory environment, economic
contraction, and rising inflation and
interest rates.
Corporate entities that we typically
consider as exposed to country risk
include companies with mainly
domestic customers, and whose businesses
are highly cyclical or greatly
affected by the general condition of
the economy, and companies with
high exposures to government sector
customers. Companies we view as less
exposed to country risk include globally
diversified and export-oriented
companies less affected by local economic
conditions and benefit from
currency depreciation.
As we noted in “2008 Corporate
Criteria: Analytical Methodology”
(section: Country Risk/Ratings Above
The Sovereign), published April 15,
2008, under our methodology, ratings
on a company may exceed those on
the sovereign, if we expect it would
continue to perform and fulfill its
financial obligations, even during a
sovereign local and/or foreign currency
default scenario. The company
must demonstrate that it is significantly
sheltered from sovereign and
country risk factors, based on past
experience and probable scenarios. In
addition, ratings above those on the
sovereign are possible where there is
strong implicit or explicit support
from a highly rated parent in another
jurisdiction, and/or there is significant
cash-flow diversity derived from operations
in several countries.
Securitizations
Outside the EMU, we consider securitizations
on a case-by-case basis for rat-
ings above the sovereign, based on
their exposure to potential direct and
indirect sovereign risk. (We have separate
criteria for the EMU.) Direct
impact would include exposure to
securities or guarantees from sovereign
or government-related entities. Indirect
impact would include the analysis of
the potential deteriorating credit
quality of securitized assets in a sovereign
downgrade or default scenario. As
we noted in “Weighing Country Risk
In Our Criteria For Asset-Backed
Securities,” (text box: How Important
Are Sovereign Ratings?), published
April 11, 2006, rating an asset-backed
security (ABS) higher than the sovereign
in which the securitized assets are
While the sovereign rating is not a “ceiling,”
entities we see as most exposed to
sovereign default risk are those least likely
to be rated above the sovereign.
25 www.creditweek.com
located implies that the structured obligation
would continue to perform in
an economic scenario in which the
government itself has defaulted. The
same factors that underlie a government
default would likely lead to deteriorating
credit performance in any
securitized asset pool whose underlying
obligors are domiciled in that country.
Q. Does the sovereign rating constitute
a “cap” or “ceiling” on the ratings of
any particular type of entity?
A. While the sovereign rating is not a
“ceiling,” entities we see as most
exposed to sovereign default risk are
those least likely to be rated above the
sovereign. These include entities with
significant exposures to sovereign securities
such as most domestic banks and
insurance companies, and defeased
securities consisting of government obligations
(defeased securities are bonds
for which the borrower sets aside cash
to pay them off).
Q. What is the transfer and convertibility
assessment, and is that a rating cap?
A. Nonsovereign foreign currency ratings
are typically the lower of the
issuer’s local currency rating and
Standard & Poor’s transfer and convertibility
(T&C) assessment. Therefore, in
countries where the T&C assessment
is not ‘AAA’, a nonsovereign’s foreign
currency rating may be limited by the
T&C assessment unless we conclude
that the relevant entity or securitization
has its own access to foreign currency
and it will not likely be affected
by sovereign actions in a sovereign
default scenario. It should be noted
that the T&C assessment is currently
‘AAA’ for the U.S., Japan, all members
of the eurozone, and sovereigns with a
‘AAA’ foreign currency rating. Foreign
and local currency ratings are equalized
for all entities domiciled in these
countries, and the T&C assessment is
not a rating constraint.
The T&C assessment reflects
Standard & Poor’s view of the likelihood
that a sovereign (or its monetary
authority) might restrict nonsovereign
access to foreign exchange needed to
pay debt service. Historically, sovereigns
suffering mounting political and
economic pressures have often tried to
restrict the ability of residents to convert
local currency to foreign currency
for the purpose of transferring that
foreign currency to other countries—
often referred to as capital flight.
While Standard & Poor’s expects sovereigns
will take measures to restrict
capital flight in severe downside scenarios,
the T&C assessment refers
only to the transfer and conversion
risk of funds related to debt service.
This is not capital flight, and sovereigns
have tended to make exceptions
for such payments in many instances.
In most countries where the sovereign
is not rated ‘AAA’, the T&C risk is
less than the risk of sovereign default
on foreign currency obligations. Thus,
most T&C assessments are higher
than the sovereign foreign currency
rating—sometimes significantly, as in
the EMU. A nonsovereign entity or

securitization can be rated above the
sovereign foreign currency rating, and
as high as the T&C assessment,
depending on such entity’s or securitization’s
operating and financial characteristics,
stress tested for a sovereign
default scenario. In theory, the T&C
assessment acts as a rating cap for
most entities domiciled in a given jurisdiction.
(For more information, please
refer to “Criteria for Determining Transfer
And Convertibility Assessments,” published
May 18, 2009. For a listing of our
current T&C assessments for rated sovereigns,
please see the most recent version
of “Sovereign Ratings And Country
T&C Assessments.”)
Q. If the sovereign rating is not a
ceiling, is there a limit to the number of
notches by which an entity’s rating can
exceed the sovereign?
A. While there is not a strict limit on
the number of notches (outside of the
EMU), there tends to be a correlation
between the highest nonsovereign ratings
and the respective sovereign rating.
This is because of the overall macroeconomic
and institutional deterioration
that tends to accompany weakening
sovereign creditworthiness, including,
but not limited to: economic contraction;
sharp price movements and higher
funding costs; risks linked to the cost
and availability of refinancing; banking
system challenges; sharp currency
movements; higher government taxes
and fees; delays in payment from government
customers; a more difficult regulatory
environment; rising labor costs;
negative demand or price developments
for products or services, or operating
and capital costs; and financial asset
price risk.
Q. Do you have criteria for rating
above the sovereign within monetary
unions, such as the EMU?
A. Yes. For entities domiciled in countries
which are members of the EMU,
see “Nonsovereign Ratings That Exceed
EMU Sovereign Ratings,” published
June 14, 2011.
Q. How are the ratings of GREs
affected by the sovereign rating?
A. A GRE’s rating usually falls
between GRE’s stand-alone credit profile
(SACP) and the respective government’s
rating. The rating considers the
likelihood, in our opinion, of sufficient
and timely extraordinary government
intervention to help the GRE meet its
financial obligations. We derive this
opinion from our assessment of how
important the GRE’s role is to the government,
plus the strength and durability
of the links between the two. A
change in a sovereign rating may result
in a change in a GRE rating, but that
will depend on our analysis of the factors
mentioned above. We may rate a
GRE above its sovereign if its SACP is
higher than the sovereign foreign currency
rating, and if we consider that
the sovereign’s willingness and ability
to impair the GRE’s credit standing in
periods of stress is limited. (See paragraphs
42 to 46 of our GRE Criteria,
“Rating Government-Related Entities:
Methodology And Assumptions,” published
Dec. 9, 2010.)
Q. Can a guarantee or other forms of
parent support mitigate sovereign and
T&C risk?
A. Yes. Offshore parent support,
including guarantees, geographic diversity
of operations and assets, and structural
features, may support ratings
above the sovereign rating and T&C
assessment.
Q. What is the potential rating gap
when the sovereign is in default?
A. As we noted in “Criteria For
Determining Transfer And Convertibility
Assessments,” published May 18, 2009,
“When a sovereign is in default or estimated
to be close to default, the gap
between the sovereign rating and the
ratings of nonsovereigns domiciled
therein may widen substantially.” This
is because a nonsovereign rating will
not follow the sovereign rating to distressed
rating categories, such as ‘CCC’
Standard & Poor’s CreditWeek | August 17, 2011 26

features special report | Q&A
27 www.creditweek.com
or ‘CC’, unless there is a clear and
present danger of default on the part of
the nonsovereign, and will not be rated
‘D’ or ‘SD’ unless the nonsovereign
itself is in default.
Q. What is the difference between a
local and foreign currency rating?
A. For most nonsovereign issuers
(excluding certain GREs), the local
and foreign currency rating will only
differ due to transfer and convertibility
risk. The foreign and local currency
ratings reflect, respectively,
Standard & Poor’s opinion of an
obligor’s willingness and ability to
service commercial financial obligations
denominated in foreign or
local currency on a timely basis.
Standard & Poor’s has generally
observed that nonsovereigns do not
distinguish between payment on obligations
based on currency, except
when there are restrictions imposed by
the sovereign (as discussed in the question
in this article on transfer and convertibility
risk). Therefore, the local
currency rating of a nonsovereign
entity reflects Standard & Poor’s
opinion of that entity’s willingness and
ability to service its financial obligations,
regardless of currency and in the
absence of restrictions on the entity’s
access to foreign exchange needed to
service debt. The foreign currency
rating of a nonsovereign incorporates
the ability of nonsovereign obligors to
access the foreign exchange needed to
meet foreign currency-denominated
obligations. Therefore, as noted
above, the foreign currency rating of a
nonsovereign is typically capped by
the T&C assessment.
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 the power to issue in local
currency and regulatory control of
the domestic financial system.
Government related entities that benefit
from the highest degree of sover-
eign support will have local and foreign
currency ratings that will
mirror—or be close to—those of the
sovereign. CW
Footnote
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, some entities with little or no government
ownership might also be considered 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.
For more articles on this topic search RatingsDirect with keyword:
Sovereign
Analytical Contacts:
Laura Feinland Katz
New York (1) 212-438-7893
Emmanuel Dubois-Pelerin
Paris (33) 1-4420-6673
Rodney A. Clark
New York (1) 212-438-7245
Vandana Sharma
New York (1) 212-438-2250
Ronald M. Barone
New York (1) 212-438-7662
Peter Kernan
London (44) 20-7176-3618
Gary Kochubka
New York (1) 212-438-2514
Nancy Gigante Chu
New York (1) 212-438-2429
Fabienne Alexis
New York (1) 212-438-7530
James Wiemken
London (44) 20-7176-7073
Gabriel Petek
San Francisco (1) 415-371-5042
Robin Prunty
New York (1) 212-438-2081
Ian Thompson
Melbourne (61) 3-9631-2100
Takamasa Yamaoka
Tokyo (81) 3-4550-8719
Marie Cavanaugh
New York (1) 212-438-7343

U.S. Downgrade Doesn’t Currently
Affect Top-Rated U.S. Nonfinancial
Corporate Borrowers
Standard & Poor’s Ratings Services
announced on Aug. 5 that it lowered
its long-term sovereign credit
rating on the United States of America to
‘AA+’ with a negative rating outlook (see
“United States Of America Long-Term
Rating Lowered To ‘AA+’,” published
on RatingsDirect, on the Global Rating
Portal). The sovereign downgrade will
not affect the ratings or stable rating outlooks
on the six U.S.-domiciled highestrated
nonfinancial corporate issuers:
Automatic Data Processing Inc. (ADP;
AAA/Stable/A-1+), ExxonMobil Corp.
(AAA/Stable/A-1+), Johnson & Johnson
(AAA/Stable/A-1+), Microsoft Corp.
(AAA/Stable/A-1+), General Electric Co.
(AA+/Stable/A-1+), and W.W. Grainger
Inc. (AA+/Stable/A-1+).
Why There Is No Impact On Our
Top-Rated U.S. Industrials
According to Standard & Poor’s criteria,
ratings on a nonfinancial corporate
borrower may exceed those on
the sovereign if we expect the borrower
to continue to fulfill its financial
obligations, even in a sovereign
Standard & Poor’s CreditWeek | 28

features special report
29 www.creditweek.com
default scenario. Depending on the
industry sector or individual company’s
financial strength, a company
may be better or less able to withstand
macroeconomic shocks or other
country-related risks. In considering
corporate ratings vis-à-vis the sovereign
rating, we consider how exposed
a company would be to a typical sovereign
stress scenario, which, in the
past, has included: sharp currency
movements, credit shortages, a weakened
banking sector, higher government
taxes and fees, late or partial
payments from the public sector, a
more difficult regulatory environment,
economic contraction, and rising
inflation and interest rates.
The U.S. sovereign downgrade also had
an effect on the credit ratings of certain
specific debt instruments.
Corporate entities that we would typically
consider the most exposed to
country risk include firms with mainly
domestic customers, highly cyclical
companies or companies for which
profitability is highly correlated with
the general condition of the economy,
and companies with high exposures to
government sector customers.
Corporate entities that typically are
least exposed to country risk include
globally diversified companies and
export-oriented companies. Local economic
conditions have less of an effect
on such companies, and they generally
benefit from currency depreciation.
Given the global and diverse business
lines and significant financial
strength of Exxon Mobil, Johnson &
Johnson, Microsoft, and General
Electric, the sovereign downgrade of
the U.S. does not affect our ratings
and rating outlooks for these U.S.
domiciled corporate issuers. They
enjoy “excellent” business risk pro-
files (see “Business Risk/Financial
Risk Matrix Expanded,” published
May 27, 2009), with end-market
diversity, diversity of product and
service lines, and a track record of
solid profitability, along with “minimal”
or “modest” financial risk,
with significant cash flow from various
businesses and substantial liquidity.
In addition, the U.S.’s transfer
and convertibility assessment remains
‘AAA’ following the sovereign downgrade.
(See “Methodology: Criteria
for Determining Transfer and
Convertibility Assessments,”published
May 18, 2009—“Ratings
Above the Sovereign’s” section. Also
see “2008 Corporate Criteria:
Analytical Methodology,” published
April 15, 2008—“Country Risk” section.)
Although there is no direct
effect on our credit ratings on these
companies from the U.S. sovereign
rating action, a weakening macroeconomic
scenario would negatively
affect the U.S. segments of their businesses
to some degree.
There is also no current effect on our
ratings or rating outlooks for ADP and
W.W. Grainger from the rating action
on the U.S. Although most of these
companies’ revenues come from within
the U.S. and they are less diversified by
product line and geographical business
mix than the previously mentioned
companies, ADP and Grainger enjoy
high customer and end-market diversification
and have revenue bases that held
up well during the recent recession. In
addition, they have minimal reliance on
the public sector, with a set of products
for which demand is relatively inelastic.
We Did Lower Ratings On The
Government-Related Entitites
In conjunction with the sovereign
downgrade, we lowered our ratings on
the three government-related entities
(GREs): Army & Air Force Exchange
Service (AAFES), Marine Corps
Community Services (MCCS), and
Navy Exchange Service Command
(NESC) to ‘AA-’ from ‘AA’, in keeping
with Standard & Poor’s criteria on
GREs. The rating outlook on AAFES is

stable, while the outlooks on MCCS
and NESC are negative. The stable
outlook for AAFES reflects its better
stand-alone credit profile than the
other two GREs. The likelihood of
extraordinary government support for
these entities, in our assessment, would
remain very high. (See Standard &
Poor’s individual research reports on
these entities on page 53.)
The Effect On Certain
Debt Instruments
The U.S. sovereign downgrade also
had an effect on the credit ratings of
certain specific debt instruments. Most
common among the affected obligations
were:
■ Bonds supported by the few remaining
‘AA+’ rated bond insurers. We revised
the rating outlooks on the ‘AA+’
bond insurers, which include Assured
Guaranty (Europe) Ltd., Assured
Guaranty (UK) Limited, Assured
Guaranty Corp., Assured Guaranty
Municipal Corp., and Berkshire
Hathaway Assurance Corp., to negative
from stable. In conjunction with
this outlook change, we also revised
the rating outlooks on the project
finance bonds backed by these
insurers to negative.
■ Defeased bonds. These are bonds
for which the borrower sets aside
cash to pay them off. We lowered
our ratings on defeased bonds
backed by U.S. Treasury securities
to ‘AA+’ from ‘AAA’.
The Impact On Defense
Contractors And
Medicare Providers
The recently enacted bill that increases
the federal debt limit includes a $350
billion reduction to previous planned
“security spending” over the next 10
years. Given that the $350 billion is
spread among a number of security
sectors, including the Department of
Defense, and is mainly back-end
loaded, Standard & Poor’s believes
there will be only a modest effect on
the credit quality of most defense contractors.
A more significant impact on
the credit quality of companies in the
defense industry could occur if
Congress does not specify additional
cuts to the overall federal budget by
the end of the year or pass a balanced
budget amendment. In these cases,
security spending could be cut by an
additional $500 billion, possibly
resulting in across-the-board cuts to
weapons programs. In response to possible
lower defense spending, military
contractors have been reducing costs to
preserve profitability and remain competitive,
as well as attempting to
increase foreign sales. (See “Planned
Cuts To The U.S. Defense Budget Are
Likely To Have A Modest Impact On
Military Contractors’ Credit Quality,”
Aug. 2, 2011.)
Significant cuts to Medicare are
likely, either as part of a special
Congressional committee’s $1.5 trillion
in spending cuts or as part of the
backup plan if the committee fails to
come to an agreement. This would be in
addition to cuts that the Affordable
Care Act of 2010 already require, such
as a $155 billion cut in Medicare payments
to hospitals over 10 years.
Medicare has more than doubled in cost
over the past 10 years, to about $550
billion annually. We have long considered
government efforts to rein in such
expenditures as a key rating risk for
health care providers. Still, surprising
government actions, such as the recently
announced 11% nursing home cuts, can
lead to credit deterioration. We placed
all six of our rated for-profit nursing
home companies on CreditWatch with
negative implications as a result of this
announcement. Providers that have
exposure to Medicare are likely to
remain at risk of more sparing reimbursement,
as long as budgetary pressures
persist (see “The Deficit Remedy
Could Be Toxic for U.S. Health Care
Companies,”on p. 37). CW
For more articles on this topic search RatingsDirect with keyword:
Corporate Borrowers
Analytical Contact:
Ronald M. Barone
New York (1) 212-438-7662
Standard & Poor’s CreditWeek | 30

features special report
Rating Actions Were
Taken On 10 U.S.-Based
Insurance Groups
Standard & Poor’s Ratings Services
lowered to ‘AA+’ from ‘AAA’ its
long-term counterparty credit and
financial strength ratings on the member
companies of five U.S. insurance groups:
Knights of Columbus, New York Life,
Northwestern Mutual, Teachers Insurance
& Annuity Assoc. of America (TIAA), and
United Services Automobile Assoc.
(USAA). The outlooks on the ratings on all
of these companies are negative.
Standard & Poor’s also lowered the ratings
on approximately $17 billion of securities
issued by New York Life, Northwestern
31 www.creditweek.com
Mutual, TIAA, USAA, and their affiliates.
(For the full rating list, see this article published
Aug. 8, 2011, on RatingsDirect, on
the Global Credit Portal.)
At the same time, Standard & Poor’s
affirmed the ‘AA+’ ratings on the members
of five other insurance groups—
Assured Guaranty, Berkshire Hathaway,
Guardian, Massachusetts Mutual, and
Western & Southern—and revised the
outlooks on ratings on these companies
to negative from stable.
The rating actions on these 10 insurance
groups follow the lowering of the longterm
sovereign credit rating on the United
States of America to ‘AA+’ from ‘AAA’
(see “United States of America Long-Term
Rating Lowered To ‘AA+’ On Political
Risks And Rising Debt Burden; Outlook
Negative,” published on Aug. 5, 2011).
We factor direct and indirect sovereign
risks—such as the impacts of macroeconomic
volatility, currency devaluation,
asset impairments, and investment portfolio
deterioration—into our financial
strength ratings. Per our criteria, the sovereign
local-currency credit rating constrains
our financial strength ratings on insurers
(see “Counterparty Credit Ratings And
The Credit Framework,” published on
April 14, 2004). The 10 affected insurance
groups operate in the U.S. and generally
have significant holdings of U.S. Treasury
and agency securities. For the insurers with
the most exposure, these investments

constituted as much as 200% of total
adjusted capital at year-end 2010.
In our opinion, very strong financial
profiles and favorable business profiles
support the ‘AA+’ ratings on the 10
affected U.S. insurance groups. In our
view, these companies maintain very
strong capital and liquidity. In addition, we
believe that the significant retail insurance
liabilities—such as whole life insurance
and deferred annuities—that some of these
companies have are less prone to withdrawals
or surrenders than institutional
liabilities. Knights of Columbus, TIAA,
and USAA also benefit from affinity relationships
with their policyholders, which
enhance the persistency of liabilities.
Our view of these companies’ fundamental
credit characteristics has not
changed. Rather, the rating actions
reflect the application of criteria and
our view that the link between the ratings
on these entities and the sovereign
credit ratings on the U.S. could
lead to a decline in the
insurers’
financial strength. This is because these
companies’ businesses and assets are
highly concentrated in the U.S.
(For related rating actions on other
U.S. financial services companies, select
GSEs, and funds, see “Ratings On Select
GREs And FDIC- And NCUA-
Guaranteed Debt Lowered After
Sovereign Downgrade,” on p. 50.)
Under our criteria, the local-currency
sovereign credit rating on the
U.S. constrains the ratings on domestic
insurance operating and holding companies.
If we were to lower our rating
on the U.S. again, we would likely
take the same rating action on the
affected insurers and their related obligations.
Alternatively, if we were to
revise the rating outlook on the U.S. to
stable, we would likely revise the outlook
on the affected insurers to stable,
assuming there is no deterioration in a
particular insurer’s business and financial
profiles. CW
For more articles on this topic search RatingsDirect with keyword:
Insurance
Analytical Contacts:
Neal Freedman
New York (1) 212-438-1274
Michael Gross
San Francisco (1) 415-371-5003
John Iten
New York (1) 212-438-1757
Neil Stein
New York (1) 212-438-5906
Patrick Wong
New York (1) 212-438-1936
David Veno
New York (1) 212-438-2108
David M. Zuber
New York (1) 212-438-1125
Kevin Ahern
New York (1) 212-438-7160
Matthew Carroll
New York (1) 212-438-3112
Gregory Gaskel
New York (1) 212-438-2787
Damien Magarelli
New York (1) 212-438-6975
Standard & Poor’s CreditWeek | August 17, 2011 32

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33 www.creditweek.com

State And Local Government
Ratings Are Not Directly
Constrained By That Of The
U.S. Sovereign
Overview
■ It is possible for state and local governments to have higher ratings than the U.S.
sovereign rating, most likely by no more than one notch.
■ We derive our credit ratings by evaluating a borrower’s individual credit factors
based on our credit rating criteria.
■ A factor in rating a state or local government above the U.S. is whether it is insulated
from negative federal intervention in fiscal management.
Despite Standard & Poor’s Ratings
Services’ downgrade of the U.S.
sovereign debt rating to
‘AA+/Negative/A-1+’, we may still
assign a ‘AAA’ rating to some state and
local governments.
We do not directly link our ratings on
U.S. state and local governments to that
of the U.S. sovereign debt rating for reasons
outlined in our criteria. However,
we recognize generally that U.S. state
and local governments’ economic performance
is frequently similar to the
nation and they share responsibility with
the federal government for some
spending items. Yet individual state and
local governments’ funding interdependencies
with the federal government vary
considerably. A minority of state and
local obligors rated by Standard &
Poor’s have achieved the highest longterm
rating of ‘AAA’. We expect that
many of these obligors, particularly
those with relatively low levels of
funding interdependencies with the federal
government or those that, in our
view, are likely to manage declines in
federal funding without weakening their
credit profile, should be able to retain
ratings above the U.S. sovereign rating if
we would otherwise assign ratings above
the U.S. sovereign rating based on our
view of other rating factors. However, in
light of the potential for common economic
and credit environments between
the U.S. and state and local governments,
we expect that in most instances
in which state and local governments
have ratings above that of the U.S., the
differential will be limited to one notch.
Our credit rating criteria allow for a
higher rating on a state or local government
than on the sovereign if, in our view,
the state or local government demonstrates
the following characteristics:
■ The ability to maintain stronger
credit characteristics than the sovereign
in a stress scenario,
■ An institutional framework that is
predictable and that is likely to limit
the risk of negative sovereign intervention,
and
■ The projected ability to mitigate negative
sovereign intervention by a high
degree of financial flexibility and
independent treasury management.
Standard & Poor’s CreditWeek | August 17, 2011 34

features special report
Pursuant to our criteria, the fiscal
autonomy, political independence, and
generally strong credit cultures of U.S
state and local governments can support
ratings above that of the U.S. sovereign.
Ability To Maintain Stronger
Credit Characteristics Than The
Sovereign In A Stress Scenario
A central feature of our U.S. public
finance criteria is the independence of
individual state and local governments
from the federal government. In part,
this is based on our view of the Tenth
Amendment to the U.S. Constitution,
which provides that rights not expressively
given to the federal government
remain with the states. Although our
ratings reflect the role of the federal
government in state and local
finances and economies, we believe
that this decentralized governmental
structure in the U.S. suggests that we
also analyze state and local government
credit quality independent of
the federal impact.
When viewing credits on a standalone
basis, we expect that some state and
local governments in the U.S. are
capable of maintaining relatively consistent
credit quality even through a
period of stress at the sovereign level.
Compared with many of their peers on
a global basis, U.S. state and local governments
function with a high level of
revenue independence. Specifically,
most state revenues (including almost
all discretionary revenue) are derived
within the states themselves, i.e., they
do not come from the federal government.
Revenues are even less linked to
the federal government at the local level
(although some state-shared revenues
originate with the federal government).
In addition, historically we have found
that state and local governments generally
have distinct credit cultures backed
by well-established frameworks that
provide for enforcement of important
public finance laws. We view this to be
important in the U.S. public finance setting
because we predominantly assign
issue ratings as opposed to issuer credit
ratings. Debt issues in the U.S. municipal
market tend to be backed by dedi-
35 www.creditweek.com
cated taxes, revenues, or fees and
include specific protections that are
legally enforceable in the U.S. context.
Given the depth and magnitude of the
U.S. economy, state and local governments
operate within a wide range of
disparate economic bases throughout
the country. We have found that some
state or local economies regularly perform
differently from that of the U.S. as
a whole. Our criteria describe how we
analyze the attributes of state and local
economies and incorporate our analysis
into our ratings. Beyond analyzing
economies in isolation, however, we
have observed that some state or local
governments have more favorable balances
between resources and responsibilities
(i.e., they may be less leveraged)
than the federal government. We believe
that certain state and local governments
have historically shown a greater commitment
to fiscal discipline or a more
resilient local economy, which may be
reflected in ratings higher than that of
the U.S. government. In a minority of
cases (3.9% of U.S. public finance ratings),
state and local governments currently
demonstrate what we consider to
be particularly strong credit characteristics
consistent with our highest rating
and, thus, are rated ‘AAA’. Because we
have assigned these ratings based on
our view of individual rating factors
pursuant to our criteria, we believe
these ratings are appropriate notwithstanding
the downgrade of the U.S. sovereign
debt rating.
A Predictable Institution
Framework, Financial
Flexibility, And Independent
Treasury Management
In our view, the institutional framework
for U.S. public finance is among the
most stable and predictable in the
world. We believe this is primarily a
result of the constitutional separation of
power between the central and subnational
levels of government that is
intended to restrain intervention in state
and local government administration.
U.S. state and local governments
enjoy considerable financial autonomy
from federal intervention. State—and in
many cases local—governments have
authority to establish and maintain laws
pertaining to tax rates and collections,
as well as the ability to add new taxes
and other forms of revenue generation.
In practice, receipt of federal funding
typically requires a state or local government
to satisfy various mandates,
such as providing certain levels of
service. And yet, participation in some
of the programs for which federal
funding is provided is voluntary. This
includes Medicaid, the largest federalstate
jointly financed social service.
In addition, U.S. state and local governments’
treasury management is independent
from the U.S. federal government.
Although we consider stress
scenarios in which federal disbursements
could be delayed or reduced,
thereby inflicting cash flow disruptions,
state and local government obligors
with ‘AAA’ ratings have, in our view,
strong access to liquidity, likely
allowing them to bridge such episodes.
Criteria Support Possibility
Of ‘AAA’ State And Local
Government Ratings
Participation in the U.S. economy and
legal system provides a platform in
which state and local governmental
obligors can generally manage their
finances and debt portfolios with considerable
independence and without
material risk of negative sovereign intervention.
In light of this independence,
our ratings largely reflect our view of
local economic characteristics or statelevel
laws that may impede or
strengthen state and local credit quality
to varying degrees. Credit implications
from these factors are detailed in our
relevant criteria documents. CW
For more articles on this topic search RatingsDirect with keyword:
State and Local Government
Analytical Contacts:
Gabriel Petek
San Francisco (1) 415-371-5042
Robin Prunty
New York (1) 212-438-2081
Steven J. Murphy
New York (1) 212-438-2066

Ratings On Certain Public Finance Debt
Issues With FHA Mortgage Guarantees
Are Placed On CreditWatch Negative
Standard & Poor’s Ratings Services
placed certain public finance debt
issues that have mortgage guarantees
from the Federal Housing
Administration (FHA) on CreditWatch
with negative implications following the
downgrade of the United States of
America to ‘AA+’ from ‘AAA’.
FHA guarantees cover nearly all the
losses from loans that have defaulted,
with FHA assuming the risk of
recouping its expenses through the
sale of the foreclosed property. The
issuer, through the loan servicer,
receives the claim from FHA for the
outstanding balance of the loan and
other expenses from FHA, but has no
claim to the sale proceeds. Therefore
in the foreclosure process on an FHA
loan, the issuer’s entire exposure is
exclusively to FHA.
Bond programs include a varying percentage
of FHA loans within their portfolios.
Standard & Poor’s plans to
assess the effect of FHA insurance on
each single-family and multifamily
whole loan indenture with FHA-guaranteed
loans. We will take any rating
action that we consider appropriate
based on Standard & Poor’s criteria. CW
For more articles on this topic search RatingsDirect with keyword:
Public Finance
Analytical Contacts:
Valerie White
New York (1) 212-438-2078
Lawrence Witte
San Francisco (1) 415-371-5037
Standard & Poor’s CreditWeek | August 17, 2011 36

features special report
37 www.creditweek.com

The Deficit Remedy
Could Be Toxic For U.S.
Health Care Companies
Overview
■ With Washington under heavy pressure to slash spending, Medicare reimbursements
have become an even greater target for cuts.
■ Standard & Poor’s factors reimbursement risk into its credit ratings on for-profit
health care providers.
■ Unexpected severe cuts to third-party reimbursement can hurt the credit quality of
health care providers with Medicare exposure.
The U.S. debt crisis has put a fire under the government’s
efforts to slow growth in health care spending. The
Centers for Medicare & Medicaid Services (CMS)
estimates that Medicare costs currently amount to roughly
$556 billion (or 3.6% of GDP), up from $247 billion (or 2.6%
of GDP) under the elder care program just 10 years ago. While
some of the increase resulted from the adoption of the Part D
prescription drug benefit in 2006, most of the expansion stems
from rising medical costs and an aging population.
Standard & Poor’s CreditWeek | August 17, 2011 38

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This new urgency to constrain Medicare
expenditure growth follows a $155 billion
reduction in Medicare payments to hospitals
over 10 years mandated under the
Affordable Care Act of 2010. Most
recently, Medicare announced an 11%
reimbursement cut for skilled nursing
facilities beginning this coming October.
Furthermore, the Joint Committee of
Congress created under the Budget
Control Act passed last week can cut
Medicare reimbursement. If the joint committee
fails to cut the deficit by its mandated
$1.2 trillion, automatic spending
cuts could be triggered and Medicare
providers would face reimbursement cuts
capped at 2% beginning in 2013.
Uncertainty about third-party reimbursement
is an ongoing risk that
Standard & Poor’s Ratings Services factors
into its ratings on health care
providers. Of the for-profit health care
providers we rate, nine garner the
majority of their revenues from Medicare,
and these companies will feel the biggest
pinch from reductions in reimbursement
or onerous changes to Medicare rules.
Moreover, while Medicare reimbursement
exposure is not the sole factor we consider
when making our risk assessments,
we characterize the business risk profiles
of most rated health care service companies
that derive 30% or more of their revenues
from Medicare as “vulnerable” or
“weak” (see “Business Risk/Financial
Risk Matrix Expanded,” published May
27, 2009, on RatingsDirect on the Global
Credit Portal, for an explanation of our
risk descriptors).
Table 1
39 www.creditweek.com
The Most Highly Exposed To
Medicare Cuts (Over 50% Of
Revenues From Medicare)
LifeCare, Gentiva, Advanced Homecare,
and Prospect Medical are the most
vulnerable of the highly exposed
Standard & Poor’s low-speculativegrade
rating on LifeCare Holdings Inc.
(CCC-/Stable/—) reflects the company’s
“highly leveraged” financial risk profile,
which features very weak cash flow protection
measures, slim liquidity, and very
high debt. The significant concentration
of Medicare reimbursement it receives
for its long-term acute-care hospital
services, coupled with its weak financial
position, makes it the most vulnerable to
further reimbursement cuts (see table 1).
Gentiva Health Services Inc. and
Advanced Homecare Holdings Inc.
operate in the home health care sector,
which is highly vulnerable to cuts, in our
opinion. The 2010 health reform legislation
targeted home health care for reimbursement
revisions. Subsequently, CMS
decreased Medicare reimbursement for
home health care providers by about 5%
in fiscal 2011. CMS has also proposed
an additional 3.5% reimbursement
reduction, along with adverse changes to
the way the home health care providers
bill for therapy. We believe that this creates
the potential for an upper-singledigit
Medicare cut for fiscal 2012.
Because hospitals are responsible for
almost one-third of all health expenditures,
they are an ongoing target of
reimbursement scrutiny. As a participant
in this sector, Prospect Medical
Companies With High (Over 50%) Exposure To Medicare
Holdings Inc. is at particular risk
because of its relatively large exposure
to Medicare.
While we already assess the financial
risk profiles of Gentiva, Advanced
Homecare, and Prospect Medical as
“aggressive” (with debt leverage of 4x
to 5x and funds from operations to debt
of 12% to 20%), even a modest
Medicare cut could weaken their credit
metrics and perhaps result in a downgrade.
Additionally, Prospect Medical’s
“vulnerable” business risk profile incorporates
its operating concentration in
California, and its consequent exposure
to vagaries in the state’s MediCal reimbursement
for indigent care (which represents
29% of Prospect’s revenues).
Renal care providers and inpatient
rehab providers are somewhat less
vulnerable, though still highly exposed
Although all of Standard & Poor’s rated
dialysis providers generate the majority
of their revenues from Medicare, these
revenues represent a significantly lower
percentage of EBITDA than for the companies
we discussed previously. More
importantly, we believe this subsector is
less likely to be the target of Medicare
cuts because of the nondiscretionary
nature of dialysis and the relatively small
percentage of government spending on
end-stage renal disease (ESRD). Also, to
limit its ESRD costs, the government can
choose to extend the number of months
that it requires private payors to pay for
dialysis. Moreover, on Jan. 1, 2011,
CMS implemented a new bundled reim-
Company Subsector Rating Business risk profile Financial risk profile Liquidity
DaVita Inc. Dialysis provider BB-/Stable Fair Significant Adequate
HealthSouth Corp. Inpatient rehabilitation B+/Positive Weak Aggressive Strong
Gentiva Health Services Inc. Home health care B+/Stable Weak Aggressive Adequate
Advanced Homecare Holdings Inc. Home health care B+/Stable Vulnerable Aggressive Adequate
Prospect Medical Holdings Inc. Hospital operator B/Stable Vulnerable Aggressive Adequate
American Renal Holdings Inc. Dialysis provider B/Stable Vulnerable Highly leveraged Adequate
Renal Advantage Inc. Dialysis provider B/Stable Vulnerable Highly leveraged Adequate
U.S. Renal Care Inc. Dialysis provider B/Stable Vulnerable Highly leveraged Adequate
LifeCare Holdings Inc. Long-term acute-care hospital CCC-/Stable Vulnerable Highly leveraged Less than adequate

ursement regime that provides annual
market-basket increases (price inflation
facing health care providers based on a
CMS price index) and targets estimated
savings of 2% in the first year.
Renal care provider DaVita Inc.’s
“fair” business risk profile is in contrast
to the “vulnerable” business risk profiles
of its rated peers. While all of these
entities are dependent on the treatment
of a single disease and have exposure to
declines in reimbursement, DaVita is
larger and more geographically diverse.
These benefits give the company more
leverage to negotiate with large commercial
payors and suppliers, which
makes DaVita more profitable than its
much smaller peers.
We do not view changes in Medicare
reimbursement as a near-term risk for
inpatient rehabilitation providers, such as
HealthSouth Corp. Medicare has already
dramatically altered its rules and regula-
Table 2
tions for both patient eligibility for coverage
and reimbursement levels. Whereas
the CMS reduced reimbursement for
skilled nursing facilities, it actually
announced a 1.1% increase in its prospective
payment rates for inpatient rehab
service providers in 2012. Our positive
rating outlook for HealthSouth reflects
our view that its credit metrics may
improve over the next year. The company
also has strong liquidity. Nevertheless,
HealthSouth’s significant reliance on
Medicare reimbursement contributes to its
“weak” business risk profile.
Companies With Substantial
Exposure To Medicare Cuts
(30% To 50% Of Revenues
From Medicare)
The credit profiles of companies that
derive 30% to 50% of revenues from
Medicare, which represent the largest
group of Standard & Poor’s rated health
Companies With Substantial (30% to 50%) Exposure To Medicare
care companies, would also be sensitive
to even a modest cut in Medicare
spending. Companies in this category
that have “highly leveraged” financial
risk profiles would be most at risk of violating
bank covenants or facing significant
drops in liquidity with a modest
Medicare cut (see table 2).
Virtually all companies in this group
have “weak” or “vulnerable” business
risk profiles, in part reflecting their substantial
Medicare exposure. A notable
exception is HCA Inc., the largest rated
for-profit hospital operator, which has a
favorable position in its competitive markets.
These factors help protect the company
from industry conditions that some
of its far smaller peers are facing and contribute
to its “fair” business risk profile.
Skilled nursing facilities
Recently, skilled nursing facilities
received the unwelcome news that
Issuer Subsector Rating Business risk profile Financial risk profile Liquidity
LifePoint Hospitals Inc. Hospital operator BB-/Stable Weak Significant Strong
Hanger Orthopedic Group Inc. Orthotics & prosthetics provider BB-/Stable Weak Aggressive Adequate
HCA Inc. Hospital operator B+/Stable Fair Highly leveraged Adequate
Health Management Associates Inc. Hospital operator B+/Stable Weak Aggressive Adequate
Drumm Investors LLC Skilled nursing provider B+/Watch Neg Weak Aggressive Adequate
Kindred Healthcare Inc. Post acute-care provider B+/Watch Neg Weak Aggressive Adequate
Select Medical Corp. Long-term acute-care hospital B/Positive Weak Aggressive Adequate
Skilled Healthcare Group Inc. Skilled nursing provider B/Watch Neg Weak Aggressive Adequate
HCR HealthCare LLC Skilled nursing provider B/Watch Neg Weak Highly leveraged Adequate
Ardent Health Services LLC Hospital operator B/Stable Weak Aggressive Adequate
Air Medical Group Holdings Medical transportation B/Stable Weak Aggressive Adequate
IASIS Healthcare Corp. Hospital operator B/Stable Weak Highly leveraged Adequate
Vanguard Health Systems Inc. Hospital operator B/Stable Weak Highly leveraged Adequate
Ameritox Ltd. Clinical diagnostics B(prelim)/Stable Weak Highly leveraged Adequate
Sun Healthcare Group Inc. Skilled nursing provider B/Watch Neg Weak Highly leveraged Adequate
Rural/Metro Corp. Medical transportation B/Stable Weak Highly leveraged Adequate
Vantage Oncology Holdings LLC Radiation oncology provider B/Stable Weak Highly leveraged Adequate
Radiation Therapy Services Inc. Radiation oncology provider B/Stable Weak Highly leveraged Less than adequate
Genoa Skilled nursing facility B/Watch Neg Vulnerable Highly leveraged Adequate
OnCure Medical Corp. Radiation oncology provider B/Stable Vulnerable Highly leveraged Adequate
Rotech Healthcare Inc. Respitorary provider B/Stable Weak Highly leveraged Adequate
Capella Healthcare Inc. Hospital operator B/Stable Weak Highly leveraged Adequate
CCS Medical Inc. Medical supplies distributor B-/Stable Vulnerable Highly leveraged Weak
Standard & Poor’s CreditWeek | August 17, 2011 40

features special report
Medicare will cut payments to nursing
homes by 11.1% and impose more
restrictive reimbursement guidelines for
therapy services. Medicare said the
reimbursement cuts, which take effect
Oct. 1, 2011, intend to “correct for an
unintended spike in payment levels and
better align Medicare payments with
costs.” As a result of the impending rate
cuts, Standard & Poor’s placed its ratings
on the six for-profit nursing home
companies we rate on CreditWatch with
negative implications.
We believe the reimbursement
changes could reduce EBITDA for these
companies by 30% to 60%, although
this rough estimate could change as fur-
Table 3
Table 4
41 www.creditweek.com
ther details emerge. The extent of the
decline for individual companies will
reflect their business mix, proportion of
nursing home service payor mix attributable
to Medicare, and the contribution
of therapy services to revenues. We
expect these companies to take actions,
including cutting expenses, that will
reduce this gross estimate. Moreover,
they may try to preserve cash flow
by reducing discretionary capital
expenditures and scaling back their
growth plans.
To resolve our CreditWatch listings,
we are reviewing the financial implications
of the reimbursement changes on
these companies—in particular, the
Companies With Moderate (20% to 30%) Exposure To Medicare
impact that potential declines in
EBITDA could have on liquidity, as well
as each company’s ability to meet or
revise tight debt covenant requirements.
Third-party reimbursement risk is an
important contributing factor in our
assessment of the business risk profiles
for each of the skilled nursing facilities
we rate as “weak” or “vulnerable.”
Hospital operators
Most of the rated for-profit hospital
companies have “weak” business risk
profiles, and as with the skilled nursing
facilities, reimbursement uncertainties
are a key factor in our assessments.
Recently, both Medicare and Medicaid
Issuer Subsector Rating Business risk profile Financial risk profile Liquidity
Laboratory Corp. of America Holdings Clinical diagnostics BBB+/Stable Satisfactory Intermediate Strong
Quest Diagnostics Inc. Clinical diagnostics BBB+/Stable Satisfactory Intermediate Adequate
Universal Health Services Inc. Hospital operator BB/Stable Fair Significant Strong
Apria Healthcare Group Inc. Home health care provider BB-/Negative Fair Aggressive Adequate
Community Health Systems Inc. Hospital operator B+/Stable Fair Highly leveraged Adequate
Emergency Medical Services Corp. Medical transportation B+/Stable Fair Highly leveraged Adequate
and physician staffing
Surgery Center Holdings Inc. Outpatient surgery provider B+/Stable Weak Aggressive Adequate
Tenet Healthcare Corp. Hospital operator B/Stable Weak Aggressive Adequate
Managed Health Care Associates Inc. Group purchasing organization B/Stable Weak Aggressive Adequate
Surgical Care Affiliates Outpatient surgery provider B/Stable Weak Highly leveraged Adequate
RadNet Management Inc. Diagnostic imaging B/Stable Weak Aggressive Adequate
Symbion Inc. Outpatient surgery provider B/Stable Weak Highly leveraged Adequate
National Specialty Hospitals Inc. Surgical hospitals B/Stable Weak Highly leveraged Adequate
Caris Diagnostics Inc. Clinical diagnostics B/Negative Weak Highly leveraged Weak
Companies With Minimal (Less Than 20%) Exposure To Medicare*
Issuer Subsector Rating Business risk profile Financial risk profile Liquidity
Team Health Inc. Physician staffing BB-/Stable Weak Significant Strong
Alliance HealthCare Services Diagnostic imaging BB-/Negative Weak Aggressive Adequate
Sheridan Healthcare Inc. Physician staffing B/Positive Weak Highly leveraged Adequate
HGI Holding Inc. Medical products distributor B/Stable Weak Highly leveraged Adequate
United Surgical Partners International Inc. Outpatient surgery provider B/Stable Weak Highly leveraged Adequate
DJO Global Inc. Medical devices B/Stable Fair Highly leveraged Less than adequate
Diagnostic Imaging Group LLC Diagnostic imaging B-/Developing Vulnerable Highly leveraged Weak
*Only includes companies with direct Medicare exposure.

eimbursement to for-profit hospitals has
been relatively flat, pressuring margins
as expenses in many different categories
have increased. Because the hospital
sector represents the single largest category
of health care spending, we believe
the federal government’s efforts to
manage the U.S. deficit could lead to significant
reimbursement cuts in this area.
Radiation oncology
All of the radiation oncology providers
we rate have “weak” business risk profiles,
in part because of their concentration
in Medicare reimbursement. These
providers have boosted revenues and
earnings in recent years by shifting to
more advanced, higher-paying treatments,
such as IMRT (intensity modulated radiation
therapy) and IGRT (image-guided
radiation therapy), from the traditional
radiation therapy. The higher margins
they are generating, however, could make
them a bigger target for Medicare cuts,
which could in turn compromise these
companies’ liquidity positions.
Companies With Moderate
Exposure (20% To 30% Of
Revenues From Medicare)
Companies with moderate (20% to 30%)
Medicare exposure can better absorb a
substantial reduction in Medicare reimbursement
because they have a more
diverse payor mix. Accordingly, 6 of the
14 companies in this group have business
risk profiles that we assess as better than
“weak” (see table 3). All six are large
leading players in their subsector and,
therefore, have more operating leverage
and more negotiating power with commercial
payors. The remaining eight
companies in this category with “weak”
business risk profiles are relatively small,
with the exception of Tenet Healthcare
Corp., which is the third-largest rated
for-profit hospital operator. Tenet’s business
risk profile reflects soft patient volumes
and a concentration in markets that
are very competitive. Moreover, it is less
profitable than its larger competitors, so
a cut in Medicare reimbursement could
potentially hurt Tenet more than
Community Health Systems Inc. or
HCA, for example.
All of the radiation oncology providers we
rate have “weak” business risk profiles, in
part because of their concentration in
Medicare reimbursement.
Clinical diagnostics
In the recent past, government reimbursement
for clinical diagnostics was flat to
slightly positive, but reimbursement pressure
from CMS remains somewhat of a
threat. In fact, CMS reduced the 2010
national fee schedule for clinical testing
services by 1.9% and instituted a 1.75%
annual fee reduction for the next five
years, beginning in 2011. In addition, a
productivity adjustment reduces the inflation
adjustment, also beginning in 2011.
The two largest players, Quest
Diagnostics Inc. and Laboratory Corp. of
America Holdings, should be able to
weather these cuts fairly easily, given large
cash flows that exceed their ongoing
needs. Caris Diagnostics Inc., however, is
much smaller and less established, and,
therefore, has less negotiating power with
the commercial payers to mitigate lower
Medicare reimbursement. We characterize
its financial risk profile as “highly leveraged,”
with a tight loan covenant cushion.
Outpatient surgery centers
Currently, reimbursement at standalone
outpatient surgery centers represents
around 60% of reimbursement at
hospital-based surgery centers. This discrepancy
may provide the outpatient
centers some protection against potential
cuts, considering that hospital-based
centers get paid significantly more for
the same procedure. Still, we view the
business risk profiles of the rated companies
in this subsector as “weak”
because of the highly competitive nature
of outpatient surgery centers and
chronic reimbursement pressure.
Companies With Minimal
Exposure (Less Than 20% Of
Revenues From Medicare)
Companies with minimal exposure to
Medicare, though least vulnerable to
Medicare cuts, still may receive relatively
low credit ratings. However, this
might be a function of their generally
highly leveraged financial risk profiles,
which overshadow their generally less
risky exposure to Medicare (see table 4).
Calls For Federal Spending Cuts
Add To Reimbursement Risk
The federal government’s focus on
containing Medicare costs—which the
recent push to reduce the national
deficit has only exacerbated—will
remain a credit concern for health
care companies. Medicare is responsible
for one-fifth of all health
spending in the U.S., and current government
estimates indicate that it will
grow at least in the mid-single-digit
percentages well into the future. Thus,
the potential for further cuts represents
a significant risk to companies
that receive more than a moderate
amount of their revenues from
Medicare. With the exception of HCA
and DaVita, we assess all of these
rated health care providers’ business
risk profiles as “weak” or “vulnerable.”
Though we have already incorporated
potential modest cuts into our
business risk profile assessment for
these companies, more substantial
cuts could have a material impact on
their financial risk profiles and liquidity,
as our recent CreditWatch listings
on the nursing home companies
demonstrate. CW
For more articles on this topic search RatingsDirect with keyword:
Health Care Companies
Analytical Contacts:
Rivka Gertzulin
New York (1) 212-438-1201
David P. Peknay
New York (1) 212-438-7852
Standard & Poor’s CreditWeek | August 17, 2011 42

features special report
43 www.creditweek.com

Not-For-Profit Health Care Ratings
No Immediate Direct
Impact, But Longer-Term
Questions Remain
The downgrade of the long-term sovereign rating on the
U.S. does not have a direct impact on ratings in the U.S.
not-for-profit health care sector, but our longer-term
concerns around government reimbursement to health care
providers continue to grow. In our view, the adequacy of future
reimbursement from government sources is a growing risk for
hospitals and health systems.
Standard & Poor’s CreditWeek | August 17, 2011 44

features special report
45 www.creditweek.com
Many of our rated health care providers
receive more than 50% of annual revenue
from Medicare, which is funded by the
federal government, and from Medicaid,
which is jointly funded by the federal government
and the states. Our view of the
fiscal stress that has contributed to the
lowered rating on the U.S. and a few U.S.
states, along with reimbursement cuts
already planned as part of the recently
passed Patient Protection and Affordable
Care Act (PPACA), plays a large role in
our assessment of growing reimbursement
risk (see “Outlook Is Stable For Not-For-
Profit Health Care Providers This Year,
But Unsettling Times Loom,” published
Jan. 26, 2011, on RatingsDirect, on the
Global Rating Portal).
Despite the large portion of revenue
derived from government programs,
we do not view the credit rating of the
governments that are the source of
those revenues, including state general
obligation bond ratings or the U.S.
sovereign rating, as limiting factors
for hospital ratings. However, pursuant
to our criteria, we consider the
fiscal condition and fiscal policies of
governments providing reimbursement
to hospitals as part of our ratings
analysis. Our view of the relatively
high level of reimbursement and regulatory
risk in the health care sector is
a component of what we see as the
sector’s industry risk. As a result of
our view of industry risk, we have not
assigned any unenhanced ‘AAA’ ratings
in the sector to date. In addition,
we have just five ‘AA+’ ratings at this
time, among approximately 560 notfor-profit
acute care credits.
Hospitals derive revenue from
Medicare and Medicaid for services provided
to patients, for whom they are
paid fees that are set by Medicare and
Medicaid, and which are not subject to
negotiation by the hospitals. A factor in
our assessment of hospital credit is the
adequacy of reimbursement, which
depends on both the level of reimbursement
and the hospital’s cost structure. In
our opinion, hospitals and health systems
have recently performed well in
managing their costs in the face of several
industry-wide challenges, including
continued growth in bad debt and
charity care, flat-to-declining patient volumes,
the rising cost of physician integration
strategies, and slowing reimbursement
from both private commercial
and governmental payors. Management
teams’ diligence in managing costs and
limiting capital expenditures, as well as
reduced new debt issuance and a
rebound in investment markets from
2009’s low, have, in our view, all contributed
to stable credit quality in the
U.S. not-for-profit health care sector.
The 2010 passage of the PPACA
increased the long-term risk we foresee
about the future adequacy of health care
reimbursement, although, according to
our calculations, the risk is minimal until
federal fiscal-year 2014. However, in our
view, the recent package increasing the
U.S. debt limit and the general fiscal condition
of the U.S which contributed to the
recent downgrade highlight future potential
reimbursement risk beyond what was
already in the PPACA. The impact on
not-for-profit health care credit ratings, if
any, will depend on our assessment of the
depth of future reimbursement cuts to
providers and the ability of hospitals to
react to those changes.
In our view, many not-for-profit hospitals
and health systems retain significant
credit strengths including, in
many cases, very strong balance sheets
and business positions, and some will
be able to weather reduced reimbursement,
should it occur, while still
retaining strong credit profiles.
However, we believe that those with
already-thin operating margins, inflexible
cost structures, and high dependence
on governmental payers are more
likely to experience credit stress over
the next few years. CW
For more articles on this topic search RatingsDirect with keyword:
Not-For-Profit Health Care
Analytical Contacts:
Liz Sweeney
New York (1) 212-438-2102
Cynthia Keller Macdonald
New York (1) 212-438-2035
Martin D. Arrick
New York (1) 212-438-7963

Certain Public Housing
Authority Government-Related
Entity Ratings Lowered
Standard & Poor’s Ratings
Services lowered the ratings on
certain public finance housing
authority issuer credit ratings following
the downgrade of the United States of
America to AA+/Negative/A-1+.
As per our government-related entity
(GRE) criteria, the GRE ratings noted
in this release are limited by the longterm
sovereign rating on the U.S. We
also consider other factors, such as
our view of the annual appropriation
risks for public housing subsidies, the
essentiality of the services provided,
and the governmental programmatic
support, into our stand-alone credit
profile ratings.
Pursuant to the GRE criteria, we believe
there is a moderate likelihood that public
housing authorities would benefit from
government support in the event of an
extraordinary circumstance. Nonetheless,
in our view, the lower U.S. sovereign
rating no longer supports a one-notch
upgrade of the stand-alone credit profile
for these affected ratings. CW
Ratings On Certain Municipal Housing
Issues Lowered To ‘AA+’
Standard & Poor’s Ratings
Services lowered the ratings on
certain public finance debt issues
that have mortgage insurance with the
Federal Housing Administration
(FHA) to ‘AA+’ from ‘AAA’. In addition,
the ratings on other public
finance debt issues that have or
potentially will have mortgage revenue
invested in short-term instruments
guaranteed by the U.S. government
have also been lowered to ‘AA+’
from ‘AAA’. Both of these ratings
actions are based on the downgrade
of the United States of America.
The ‘AA+’ rating on the affected
debt issues is based on our view of the
strength of the guarantees supporting
the mortgage payments as well as the
investments in which monthly mortgage
payments are deposited to make
semiannual bond payments. In the
For more articles on this topic search RatingsDirect with keyword:
Public Housing
Analytical Contacts:
Valerie White
New York (1) 212-438-2078
Mikiyon Alexander
New York (1) 212-438-2083
cases of the affected issues, FHA provides
the guarantee for the monthly
mortgage payments. Mortgage payments
are invested in either a guaranteed
investment contract or are
invested in short-term instruments
that either currently are, or could be,
guaranteed by the U.S. government. In
our view, the credit strength of these
bonds is based solely on the guarantee
of FHA and, as such, will reflect the
ratings of the U.S. government of
which the FHA is an agency. CW
For more articles on this topic search RatingsDirect with keyword:
Municipal Housing
Analytical Contacts:
Valerie White
New York (1) 212-438-2078
Stephanie Morgan
New York (1) 212-438-5141
Standard & Poor’s CreditWeek | August 17, 2011 46

features special report
Ratings On U.S. Municipal Housing Issues Guaranteed By
Fannie Mae And Freddie Mac Lowered To ‘AA+’
Standard & Poor’s Ratings Services
lowered the ratings on certain
public finance debt issues that
have credit enhancement guaranteed by
Federal National Mortgage Association
(Fannie Mae) and Federal Home Loan
Mortgage Corp. (Freddie Mac) to
‘AA+/A-1+’ from ‘AAA/A-1+’ following
the downgrade of Fannie Mae and
Freddie Mac to ‘AA+/Negative/A-1+’.
The outlook is negative.
The rating on the affected debt issues
is based on the rating on either Fannie
Mae or Freddie Mac, which either guarantees
direct payment on the bonds, or
in some circumstances, guarantees
mortgage payments in the event of a
mortgage default. In the cases of the
affected issues, the guarantee is irrevocable
and is in place until bond maturity.
As such, the bonds carry the rating
on Fannie Mae or Freddie Mac.
Among the bonds whose ratings have
been lowered are bonds issued by the
housing finance agencies’ New Issues
Bond Program through which bonds are
enhanced in the form of the Temporary
Credit & Liquidity Program (TCLP).
Under the TCLP, there is one master
irrevocable standby temporary credit
Standard & Poor’s Ratings Services
lowered the ratings on certain public
finance debt issues that have credit
enhancement guarantees by certain government-related
entities in the form of a mortgage-backed
security (MBS) to ‘AA+’ from
‘AAA’. The rating actions follow the downgrade
of the United States of America.
The ‘AA+’ rating on the affected debt
issues is based on our view of MBS
enhancements that make mortgage payments
in the event of a mortgage default.
In the cases of the affected issues, the
enhancement is irrevocable and is in place
47 www.creditweek.com
and liquidity facility issued by Fannie
Mae and Freddie Mac in favor of the
trustee. The facility guarantees credit
and liquidity on the bonds. As such,
pursuant to our criteria, the ratings on
the issues follow the ratings on Fannie
Mae and Freddie Mac. CW
Ratings On Municipal Housing Issues Backed
By The U.S. Government Are Lowered To ‘AA+’
until bond maturity. Payment on the MBS
enhancements provided by Federal
National Mortgage Association (Fannie
Mae) and Federal Home Loan Mortgage
Corp. (Freddie Mac) are guaranteed by
those entities. The ratings on those issues
reflect our view of the support likely to be
provided by the U.S. government. Payment
on the MBS enhancements backed by
Governmental National Mortgage
Association (Ginnie Mae) is backed by the
full faith and credit of the government, and
the ratings on those issues reflect the rating
of the U.S. government. CW
For more articles on this topic search RatingsDirect with keyword:
Municipal Housing
Analytical Contacts:
Valerie White
New York (1) 212-438-2078
Stephanie Morgan
New York (1) 212-438-5141
For more articles on this topic search RatingsDirect with keyword:
Municipal Housing
Analytical Contacts:
Valerie White
New York (1) 212-438-2078
Lawrence Witte
San Francisco (1) 415-371-5037

Ratings On Energy Northwest, WA And
Bonneville Power Administration, OR
Lowered To ‘AA-/Stable’
Standard & Poor’s Ratings Services lowered its rating on Energy Northwest
(ENW), Wash.’s revenue bonds and the several nonfederal debt obligations
that the Bonneville Power Administration (BPA), Ore., pays as operating
expenses of its electric system to ‘AA-’ from ‘AA’. The outlook is stable. The rating
action reflects the interplay between our rating on the United States of America
(AA+/Negative/A-1+) and BPA’s ‘aa-’ standalone credit profile. Because the United
States government’s rating is now ‘AA+,’ and because we believe that there is a
“moderately high” likelihood that the U.S. government would provide
extraordinary support to BPA under our government-related entities criteria, we no
longer provide ratings uplift to BPA’s ‘aa-’ standalone credit profile.
Standard & Poor’s CreditWeek | August 17, 2011 48

features special report
BPA has no direct capital markets debt,
but has entered agreements that we
understand require it to treat debt service
on $6.2 billion of nonfederal debt as an
operating expense ahead of servicing
$6.9 billion of federal debt. Although
ENW’s bonds are subordinate ENW obligations,
ENW covenanted to close the
prior lien. Closed-lien, senior debt represents
less than 8% of nonfederal debt.
BPA’s nonfederal obligations include:
■ $5.9 billion of ENW revenue and
refunding bonds;
■ $122.4 million of Public Utility
District No. 1 of Lewis County,
Wash., Cowlitz Falls Project bonds;
■ $119.6 million of Northwest
Infrastructure Financing Corp.
(Schultz-Wautoma project) bonds;
Standard & Poor’s Ratings
Services lowered the long-term
rating on Tennessee Valley
Authority by one notch, to ‘AA+’ from
‘AAA’. At the same time, we removed
the rating from CreditWatch with negative
implications. The outlook is negative.
The rating action reflects the interplay
between our rating on the United
States of America (AA+/Negative/A-1+)
and TVA’s ‘aa-’ stand-alone credit profile.
Because the U.S. government rating
49 www.creditweek.com
■ $22.8 million of Northern Wasco
Public Utility District, Ore. (McNary
Dam Project) bonds;
■ $13.7 million of conservation and
renewable energy system bonds; and
■ $8.1 million of Tacoma, Wash., conservation
system project bonds.
The stable outlook reflects our view
that Bonneville’s standalone credit
profile could withstand even the possibility
of some further negative rating
actions on the federal government’s
sovereign ratings, if such actions were
to occur. Also, we think the nearly 8%
average rate increases established in
BPA’s recently concluded rate proceeding
covering the two fiscal years
beginning in October 2011will help
address recent years’ erosion of debt
is now ‘AA+,’ we have reduced the uplift
TVA’s ‘aa-’ stand-alone credit profile
receives under our government-related
entities criteria. Nevertheless, the continuing
ratings uplift reflects our opinion
that there is an extremely high likelihood
that this corporation, which is
wholly owned by the U.S. government,
would receive extraordinary federal support
in the event of financial distress.
As of March 31, 2011, the Knoxville,
Tenn.-based authority had $26.2 billion
service coverage and liquidity due to
weak hydrology conditions and soft
wholesale power markets. We expect
that the rating could be lowered if BPA
continues producing cash basis coverage
of federal and nonfederal obligations
below 1x, as it did in 2009 and
2010, and its robust liquidity cushion
continues to erode. CW
For more articles on this topic search RatingsDirect with keyword:
Northwest
Analytical Contacts:
David Bodek
New York (1) 212-438-7969
Theodore Chapman
Dallas (1) 214-871-1401
Tennessee Valley Authority Rating Lowered To ‘AA+’ After
U.S. Downgrade; Outlook Is Negative
of debt and other financing obligations
outstanding, including statutory debt,
energy prepayment obligations, leaseleaseback
transactions, and other obligations.
Management has recorded an
estimated charge of $1.1 billion for
expected cleanup and related costs
attributable to the December 2008
Kingston coal ash spill in Tennessee.
“The negative outlook reflects the
outlook of the United States as TVA’s
sponsoring sovereign,” said credit analyst
Theodore Chapman. “While we
note that the stand-alone credit profile
of TVA is not without challenges, both
financial and operational, we do not
currently believe these challenges measurably
pressure the stand-alone credit
profile during our outlook horizon of
the next two years.” CW
For more articles on this topic search RatingsDirect with keyword:
Tennessee Valley Authority
Analytical Contacts:
Theodore Chapman
Dallas (1) 214-871-1401
David Bodek
New York (1) 212-438-7969

Ratings On Select GREs And FDIC-
And NCUA-Guaranteed Debt Lowered
After Sovereign Downgrade
Standard & Poor’s Ratings Services
lowered its issuer credit ratings and
related issue ratings on 10 of 12
Federal Home Loan Banks (FHLBs) and
the senior debt issued by the FHLB System
to ‘AA+’ from ‘AAA’. We have also lowered
the ratings on the senior debt issued
by the Federal Farm Credit Banks to ‘AA+’
from ‘AAA’. The ratings on the individual
farm member banks are not affected.
In addition, we have lowered the senior
issue ratings on Fannie Mae and Freddie
Mac to ‘AA+’ from ‘AAA’. Our ‘A’ subordinated
debt rating and our ‘C’ rating on
the preferred stock of these entities
remain unchanged. Finally, we have
affirmed the short-term issue ratings for
these entities at ‘A-1+’ and removed them
from CreditWatch Negative, where they
were placed July 15, 2011.
The downgrades of Fannie Mae and
Freddie Mac reflect their direct reliance on
the U.S. government. Fannie Mae and
Freddie Mac were placed into conservatorship
in September 2008, and their ability
to fund operations relies heavily on the
U.S. government. In addition to the
implicit support we factor into our ratings,
Standard & Poor’s CreditWeek | August 17, 2011 50

features special report
51 www.creditweek.com
Under our GRE criteria, the Farm Credit
System is classified as having a very high
likelihood of receiving support from the
government if needed.
the U.S. Treasury has demonstrated
explicit support by providing these entities
with capital quarterly, as necessary.
The downgrades of 10 of the 12 FHLBs
and the FHLB System’s senior debt reflect
a one-notch reduction in the U.S. sovereign
rating. Before we downgraded the
U.S., under our GRE criteria, 10 of the 12
FHLB banks were rated ‘AAA’, the same
level as the U.S. sovereign because they
have either ‘aa+’ or ‘aa’ stand-alone credit
profiles and we classify them as having a
very high likelihood of receiving support
from the government if needed. The
FHLBs of Chicago and Seattle were
already rated ‘AA+’ prior to the U.S. sovereign
downgrade as they have lower
stand-alone credit profiles (‘aa-’ and ‘a+’,
respectively) than the other 10 FHLBs.
The FHLB System is classified as being
almost certain to receive government support
if necessary under our GRE criteria.
Thus, the FHLB System debt is rated at
the same level as the U.S. sovereign rating.
The implicit support that we factor into
the issuer and issue credit ratings relates to
the important role the FHLBs and the
FHLB System play as primary liquidity
providers to U.S. mortgage and housingmarket
participants.
The downgrade of the senior debt issued
by the Farm Credit System reflects a onenotch
reduction in the U.S. sovereign
rating. Under our GRE criteria, the Farm
Credit System is classified as having a very
high likelihood of receiving support from
the government if needed. The Farm
Credit System’s stand-alone credit profile is
‘aa’. Thus, under our criteria, the notches
of uplift that we factor into the ratings on
debt issued by the System decrease to one
notch from two notches when the sovereign
has a ‘AA+’ rating rather than a
‘AAA’ rating. The issuer credit ratings on
the four Farm Credit System Banks that
we rate are unaffected by the downgrade
of the U.S. sovereign given their ‘a+’ standalone
credit ratings and high likelihood of
support classification under our GRE criteria.
The implicit government support
that we factor into our ratings for the
Farm Credit System debt and the four
rated banks considers the system’s mission
to provide stable and reliable funding to
the U.S. agricultural and rural sectors.
We have also lowered the ratings on 126
Federal Deposit Insurance Corp.-guaranteed
debt issues from 30 financial institutions
under the Temporary Liquidity
Guarantee Program (TLGP), and four
National Credit Union Association-guaranteed
debt issues from two corporate
credit unions under the Temporary
Corporate Credit Union Guarantee
Program (TCCUGP) to ‘AA+’ from ‘AAA’.
The downgrades on the TLGP and
TCCUGP issues reflect their direct credit
support from the U.S. Treasury for timely
and ultimate repayment.
The TLGP was formed to facilitate
capital-markets borrowing for U.S.
banks and bank holding companies
during the global credit crisis. Similarly,
the TCCUGP was formed to assist corporate
credit unions that ran into financial
difficulties as a result of significant
losses in their investment portfolios.
(For related rating actions on other U.S.
financial services companies, please see
“Ratings On The U.S. Central Securities
Depository And Three Clearinghouses
Lowered” on p. 52.) CW
For more articles on this topic search RatingsDirect with keyword:
GREs
Analytical Contacts:
Matthew Albrecht
New York (1) 212-438-1867
Daniel E. Teclaw
New York (1) 212-438-8716
Sunsierre Newsome
New York (1) 212-438-2421

Ratings On The U.S. Central
Securities Depository And
Three Clearinghouses Lowered
Standard & Poor’s Ratings Services
lowered its long-term counterparty
credit ratings on The Depository
Trust Co. (DTC), National Securities
Clearing Corp. (NSCC), Fixed Income
Clearing Corp. (FICC), and Options
Clearing Corp. (OCC) to ‘AA+’ from
‘AAA’. These companies are removed
from CreditWatch Negative, where they
were placed July 15, 2011. The applicable
short-term counterparty credit ratings are
unaffected. The outlooks on DTC and the
three clearinghouses are negative.
The rating actions on DTC, FICC,
NSCC, and OCC follow the lowering of
the long-term sovereign credit rating on
the U.S. The downgrades of these 4
financial institutions are not the result
of any company-specific event. We have
not changed our view of the fundamental
soundness of their depository or
clearing operations. Rather, the down-
grades incorporate potential incremental
shifts in the macroeconomic
environment and the long-term stability
of the U.S. capital markets as a consequence
of the decline in the creditworthiness
of the federal government.
As per our published criteria, sovereign
credit risk is a key consideration in our
assessment of financial institutions.
Consequently, the sovereign rating on the
U.S. constrains the ratings on DTC, FICC,
NSCC, and OCC, because their respective
businesses and the assets they hold are
concentrated in the domestic market.
They are exposed to direct and indirect
sovereign risks, such as macroeconomic
volatility and collateral impairment.
(For related actions on other U.S.
financial institutions, please see “Ratings
On Select GREs And FDIC- and
NCUA-Guaranteed Debt Lowered After
Sovereign Downgrade,” on p. ) The
outlooks on DTC, FICC, NSCC, and
OCC, are negative because the long-term
U.S. sovereign rating constrains the ratings
on domestic exchanges and clearinghouses.
If we were to lower our U.S. sovereign
rating, then we would likely lower
our ratings on DTC and the 3 independent
clearinghouses. If we were to
revise the outlook on the U.S. to stable,
we would likely revise the outlooks on
these 4 financial institutions in the
absence of company-specific financial
safeguard-package deterioration. CW
For more articles on this topic search RatingsDirect with keyword:
Clearinghouses
Analytical Contacts:
Nik Khakee
New York (1) 212-438-2473
Daniel Koelsch
Toronto (1) 416-507-2590
Standard & Poor’s CreditWeek | August 17, 2011 52

features special report
53 www.creditweek.com

U.S. Military Exchange
Services Lowered
To ‘AA-’ After
Sovereign Downgrade
Standard & Poor’s Ratings Services lowered its corporate credit rating
on Army & Air Force Exchange Service (AAFES), the Navy Exchange
Service Command (NEXCOM), and the Marine Corps Community
Services (MCCS) to ‘AA-’ from ‘AA’. At the same time we affirmed our
‘A-1+’ short-term rating on these government-related entities (GRE). In
addition, we removed all the ratings from CreditWatch, where they were
placed with negative implications on July 15, 2011. The outlook on AAFES
is stable, while that on NEXCOM and MCCS is negative.
“The downgrade reflects the GRE link
with the United States of America, for
which our long-term sovereign rating is
now ‘AA+’, with a negative outlook,”
said credit analyst Helena Song.
The ‘AA-’ rating on AAFES, NEXCOM,
and MCCS reflects Standard & Poor’s
opinion that there is a very high likelihood
the U.S. government would provide
timely and sufficient extraordinary
support to all three in the event
of financial distress. We assess the
standalone credit profiles (SACP) of
AAFES as ‘a’.
In accordance with our criteria for
GREs, our view of a very high likelihood
of extraordinary government
support is based on our assessment of:
■ Their very important role as providers
of services to military personnel around
the world, including meeting key political
(military-related) objectives of the
government and in the implementation
of key national policies; and
■ The very strong link they have with
the U.S. government.
Although our ratings outlook on the
U.S. is negative, our outlook on
AAFES is stable. Based on our GRE
criteria, a future downgrade of the
U.S. to ‘AA’ or ‘AA-’ would not result
in another downgrade of AAFES. Our
outlook on NEXCOM and MCCS is
negative. Based on our GRE criteria, a
future downgrade of the U.S. to ‘AA’
or ‘AA-’ would result in another
downgrade of NEXCOM, while we
would lower our corporate credit
rating on MCCS to ‘A+’.
Our ‘a’ stand-alone credit profile
on all three should also remain
unchanged. CW
For more articles on this topic search RatingsDirect with keyword:
Army & Airforce
Analytical Contacts:
Helena Song
New York (1) 212-438-2477
Mariola Borysiak
New York (1) 212-438-7839
Standard & Poor’s CreditWeek | August 17, 2011 54

features special report
55 www.creditweek.com

Asia-Pacific Sovereigns
Not Directly Affected, But Long-Term
Consequences Could Be Negative
Standard & Poor’s Ratings Services said that in and of itself,
there is no immediate impact on Asia-Pacific sovereign ratings
resulting from the lowering of the issuer credit ratings on the
U.S. to ‘AA+’ on August 5. However, the U.S. rating change, together
with the weakening sovereign creditworthiness in Europe, does
point to an increasingly uncertain and challenging environment
ahead. Uncertainties in the global financial market and weakened
prospects in the developed economies have further undermined
confidence. The potential longer-term consequences of a
weaker financing environment, slower growth, and higher risk
aversion are negative factors for Asia-Pacific sovereign ratings.
For the moment, the generally
stable outlooks for Asia
Pacific sovereigns (with the
exception of New Zealand,
Japan, Vietnam, and the
Cook Islands) is supported by
sound domestic demand, relatively
healthy corporate/household
sectors, plentiful external
liquidity, and high domestic savings
rates. Our baseline assumption
of no likely abrupt dislocations
in developed economies’
financial and real economies underpins
this opinion.
However, given the interconnectivity of
the global markets, an unexpectedly sharp
disruption in developed world financial
markets could change the picture. It could
lead the U.S. and European economies
into deep contractions again, or further
delay their recoveries. In this scenario, the
experience of the global financial crisis of
2008 and 2009 shows that exportdependent
economies with large exposures
to the U.S. and/or Europe would feel
the most pronounced economic impacts.
It’s not likely things would be very different
this time. U.S. and Western Europe
remain significant markets for Asia-Pacific
exports, even if their importance has
declined over the past couple of years compared
with intraregional and Central &
Eastern European/Middle East/Latin
American trade. Specifically, Thailand,
Taiwan, Korea, Malaysia, the Philippines,
Japan, Australia, and New Zealand are
likely to experience export-driven slowdowns
either through weaker demand or
lower export prices, or both.
At the same time, the Asia-Pacific sovereigns
that have weaker external positions
could come under pressure as international
liquidity tightens. Some may require
additional external assistance to prevent
sharp economic adjustments. Those with
financial systems reliant on off-shore markets
may face reduced liquidity and a
heightening of refinancing risk in the near
term. To varying degrees, Pakistan, Sri
Lanka, Fiji, Australia, New Zealand,
Korea, and Indonesia may be affected.
The adverse impact on Asia Pacific in
that scenario would likely require
Standard & Poor’s CreditWeek | August 17, 2011 56

features special report
governments to use their balance sheets
to support their economies and financial
sectors once again. And in our
opinion, most governments would
promptly oblige. But some of them continue
to bear the scars of the recent
downturn—the fiscal capacities of
Japan, India, Malaysia, Taiwan, and
New Zealand have shrunk relative to
Standard & Poor’s Ratings
Services believes that in and of
itself, there is no immediate
impact on Asia-Pacific corporate,
financial institutions, project finance,
or structured finance ratings resulting
from the lowering of the issuer credit
rating on the U.S. to ‘AA+’ on August
5. However, the U.S. rating change,
together with the weakening sovereign
creditworthiness in Europe, does point
to dampened market sentiment, potential
rising funding costs in offshore
markets, and reduction/reversal of capital
flows. Mitigating factors for the
region include a still-positive economic
growth outlook for Asia Pacific,
together with generally strong domestic
saving rates and healthy household and
corporate sectors.
Sovereigns
There is no immediate impact on Asia-
Pacific sovereign ratings, although the
potential longer-term consequences of a
weaker financing environment, slower
growth, and higher risk aversion are negative
factors.
Corporates & Infrastructure
The direct impact on Asia Pacific’s corporate
and infrastructure sectors is
likely to be limited. However, a prolonged
market disruption—given the
interconnectivity of the global markets—would
possibly result in increased
spreads, reduced liquidity, and heightened
refinancing risks. This would most
adversely impact highly leveraged entities
seeking rollover of debt or new
funding. Having said that, a large
57 www.creditweek.com
pre-2008 levels. If a renewed slowdown
comes, it would likely create a deeper
and more prolonged impact than the
last one. The implications for sovereign
creditworthiness in Asia-Pacific would
likely be more negative than previously
experienced, and a larger number of
negative rating actions would follow.
We wait to see. CW
U.S. Downgrade Has No Immediate Impact On Asia-Pacific Ratings
number of infrastructure companies,
utility companies, and Chinese property
developers have been taking active forward
measures in their debt scheduling.
Furthermore, significantly weaker U.S.
demand would likely dampen sentiment
worldwide, and hence could place
strong pressures on the profitability of
large exporters from China, Korea,
Japan, Singapore, and Hong Kong.
Finally, the corporate sector would
need to contend with fluctuations in
exchange rates and sharp movements in
input costs (higher spreads and commodity
price movements).
Financial Services
In our opinion, the immediate effect on
the Asia Pacific financial sector would,
at worst, be a rise in spreads that would
marginally raise the funding costs of the
Australian, Korean, and Japanese banks
that have some dependence on offshore
funding markets. A sharp market reaction
in Asia Pacific—especially if there
is reduction/reversal in capital inflows
from the U.S. and Europe—could
impact a broader swathe of banks and
insurers through declines in the market
values of their investment assets
(market-to-market accounting) and
pressure on their capital marketdependent
income. Credit quality of
banks’ corporate loan books, especially
the export sectors, could come under
pressure if financing costs rise simultaneously
with declining revenue. The
overall near-term impact could dent the
sector’s profitability, but would unlikely
inflict damage to balance sheets. We do
not expect the market impact to be
For more articles on this topic search RatingsDirect with keyword:
Asia-Pacific
Analytical Contacts:
Elena Okorotchenko
Singapore (65) 6239-6375
Takahira Ogawa
Singapore (65) 6239-6342
KimEng Tan
Singapore (65) 6239-6350
severe enough to erode depositor confidence,
which should sustain the retail
deposit base that is the mainstay of
funding for Asia Pacific’s banks. Given
the still-positive economic growth
prospects of Asia Pacific, the region’s
healthy household and corporate sectors,
and the generally sound financial
profile of Asia Pacific’s financial institutions,
we do not expect rating changes
to result from this development.
Structured Finance
The direct impact on Asia Pacific structured
finance markets is also likely to be
limited, at this stage. While there is a
small number of transactions that may
have direct exposure to U.S. sovereign
debt by way of collateral investments, it
is relatively modest. The more likely
rating impact would be through counterparty
exposures to regional and
global banks should they be affected by
altered market conditions. Additionally,
the potential impact of broader economic
and liquidity access could indirectly
impact structured finance ratings
performance over time. CW
For more articles on this topic search RatingsDirect with keyword:
Asia-Pacific
Analytical Contacts:
Ritesh Maheshwari
Singapore (65) 6239-6308
JaeMin Kwon
Hong Kong (852) 2533-3539
Andrew Palmer
Melbourne (61) 3-9631-2052
Peter Eastham
Melbourne (61) 3 9631 2056

Transcript Of Teleconference Held On Aug. 10, 2011
The Impact Of Standard & Poor’s U.S.
Downgrade On Other Asset Classes
On Aug. 5, 2011, Standard & Poor’s Ratings Services
lowered its long-term sovereign credit rating on the
United States of America to ‘AA+’ from ‘AAA’ and
affirmed its ‘A-1+’ short-term rating. Standard & Poor’s also
removed the short- and long-term ratings from CreditWatch,
where they were placed with negative implications on July 14,
2011. (See the full report, “United States of America Long-
Term Rating Lowered To ‘AA+’ On Political Risks And Rising
Debt Burden; Outlook Negative,” published Aug. 5, 2011, on
RatingsDirect on the Global Credit Portal and our Web page,
www.standardandpoors.com.)
Standard & Poor’s CreditWeek | August 17, 2011 58

features special report
As a follow-up to the teleconference
held on Aug. 8 that covered the key reasons
behind the downgrade on the U.S.,
Standard & Poor’s held a teleconference
on Aug. 10 to discuss the impact of the
downgrade on various other asset
classes and securities that we rate. (For
the teleconference replay and related
articles that were published over the
past week, please go to our Web site:
www.standardandpoors.com.)
Standard & Poor’s senior analysts
from the sovereign, U.S. public finance,
corporate, financial institution, and
structured finance teams discussed the
direct and indirect impact of the downgrade
on various sectors:
■ Nikola Swann, Director, Sovereigns
■ Laura Feinland Katz, Managing
Director, Criteria Officer, Analytics
Policy Board
■ Matt Albrecht, Associate, Financial
Institutions
■ Rodney Clark, Managing Director,
Insurance
■ Steve Murphy, Managing Director,
U.S. Public Finance
■ Valerie White, Senior Director, U.S.
Public Finance, Housing
■ Peter Murphy, Senior Director, U.S.
Public Finance, Infrastructure
■ Gabriel Petek, Senior Director, U.S.
Public Finance, State Ratings
■ Ronald M. Barone, Managing Director,
Corporate Ratings
■ Robert Chiriani, Senior Director,
Structured Finance
Bruce Schachne, vice president and
head of market development for
Standard & Poor’s in New York moderated
the conference call and asked questions
of the speakers, which had been
submitted by listeners.
59 www.creditweek.com
Bruce Schachne: Today’s teleconference
is a follow-up to the teleconference we had
on Monday in which we talked in detail
about the rationale behind Friday’s rating
action in which we downgraded the U.S.
rating to ‘AA+’. Today we will be focusing
on the impact of the downgrade on the
various other asset classes and securities
that we rate. We have a number of
speakers representing the various practices
at Standard & Poor’s. To start today’s call I
The U.S. ratios continue to weaken while
we expect the other countries’ ratios to
stabilize or improve.
would like to introduce Nikola Swann, the
lead analyst for the U.S. rating. Nikola will
be giving us just a brief overview of the
rationale behind our downgrade decision.
Nikola Swann: So why did we downgrade
the U.S. sovereign rating to ‘AA+’ on
Friday and leave the outlook negative? The
reasons for the downgrade can be best
understood if I just remind people of the
basic elements of our sovereign criteria.
You have five main categories of
analysis for all sovereign ratings and
some of these we still view as strengths
for the U.S. The five are basically political
analysis, economic analysis, monetary,
external, and fiscal.
Strengths that we still see in the U.S. are
the economy, which we believe has very
high growth potential for a high-income
country, with lots of flexibility. We also
think that monetary flexibility is very
strong. The institutions and the Federal
Reserve, we think, are quite well established.
They have good credibility. Inflation
has been low and stable for a long time. On
the external side, we note that the international
investment position shows very high
net external debt—one of the highest in the
world in fact—so that’s a significant negative.
But it’s in large part offset in our minds
by the exceptional strength that you have
in terms of liquidity with the U.S. dollar,
which remains the global reserve currency.
So the monetary and economic pillars are
strengths. The external is more or less neutral.
Now, we move to the other two categories
and these are the primary reasons
that we downgraded the U.S.
First on the fiscal side, the net indebtedness
of the United States used to be a relative
strength compared to ‘AAA’ rated
peers. We think in particular of the United
Kingdom, France, Germany, and Canada
as very close peers to the United States.
And relative to especially France and
Germany, the United States used to have
quite a bit lower debt burden as a share of
GDP, talking about general government
debt net of financial assets, the debt of all
layers of government.
That has changed over the past 10
years. There was steady deterioration
from the early 2000s with the slip back
into deficits after the fiscal discipline of
the late 1990s was lost. That deteriorated
markedly from 2008, with the financial
crisis and serious recession, and it has not
recovered and we note that the trajectory
of debt to GDP continues to rise.
And we continue to expect it to rise
despite the Budget Control Act passed last
week—the agreement of Aug. 2. We
believe that for the next five years, which is
the focus of our ratings horizon, that debt
to GDP is likely to continue to rise in spite
of that agreement. And that’s assuming
that the agreement is fully implemented.
The U.S. right now has ratios that are
no longer a strength compared to those
countries and the U.S. ratios continue to
weaken while we expect the other countries’
ratios to stabilize or improve.
Finally, there is the political analysis,
which is an important element of our sovereign
criteria. You have to remember, of
course, that with sovereigns, unlike most
issuers, the question not only of ability to
pay but also of willingness to pay is quite
an important one because there is no one
who can force a sovereign to pay its debt.
You also cannot force a sovereign into
bankruptcy. So we have to look at the
willingness and that is done primarily by
analyzing the politics. You look here both
at how important from a policy perspective
paying the nation’s debts is and also

how much proactive, effective, and stable
policymaking there is to ensure fiscal sustainability
over the long term.
We think that this also has deteriorated
in recent years compared to other
‘AAA’ countries. That was why we
moved to a negative outlook in April,
due to both the fiscal and the political
realities. And that went on as we
watched the fiscal debates going on
intensely for many months this year and
we noticed how little progress was
being made in terms of bridging the gap
between the two sides, one very focused
on revenue measures to address the
deficit issues, the other very focused on
expenditure and not much common
ground between them.
We noticed that there was not much
moving together despite many months of
debate. In addition to this we had serious
questions being raised about the debt
ceiling. While we have raised the debt
ceiling many times in the past 50 years, we
believe that the debate that we had this
year was even more contentious and
unproductive than previous ones.
And the fact is, we had a large proportion
of—not just anyone—but elected
officials who seemed to be seriously advocating
that paying U.S. government debt
in full and on time was less important
than other domestic priorities that they
advocated. That’s something that you
don’t see happen in ‘AAA’ countries.
As a result of that and what we view as
very slow progress in addressing both the
medium-term and the longer-term fiscal
issues, we view the politics in the U.S. as
moving away from what you have in a
‘AAA’ country. Just one example of what I
mean by that: In terms of coming to an
agreement on a fiscal consolidation program
(if we are willing to accept that the
agreement from Aug. 2 is an initial small
measure of fiscal consolidation), many past
such measures that seemed good intentioned
at the time were later overturned by
subsequent Congresses.
We do have that track record. But that
aside, if you consider how long it took to
get that agreement and how important it
is, measured against the size of the
problem, you notice a gap compared to
other countries. You notice that France,
Germany, the U.K., and Canada have
already begun to address their deficits and
to recover lost ground from the recession
and financial crisis well before the U.S.
And if you compare the size, in the
U.S. and the U.K. you had the general
government deficit increase to 10% of
GDP and higher, a level that is almost
unheard of, during recession. And to
address that, the United Kingdom last
year passed, and began to implement, a
detailed fiscal consolidation program
that will result, when it is fully implemented,
in the shrinking of that deficit
on the order of 7.5% of GDP per year.
The agreement that we saw on Aug. 2
in the U.S. is projected to result in, at best
(if fully implemented), shrinking the general
government deficit by on the order of
1.5% of GDP per year. So our rating
committee decided that the level of seriousness
in addressing the fiscal consolidation
that is needed in the U.S. just was not
at the ‘AAA’ level any more.
I should also mention that the negative
outlook remains on the ‘AA+’ long-term
rating. That does mean that we do see a
chance of at least one-third that we could
lower it further in the next two years.
That could happen if fiscal outturns are
worse than what we currently expect or if
the politics seem to be getting worse.
If the agreement is fully implemented,
and we believe that that is holding, and
we see even further progress than what
was agreed on Aug. 2, then that would
be likely to stabilize the ratings at ‘AA+’.
Schachne: Is there a knock-on or a
ripple effect on other sovereigns rated
by Standard & Poor’s?
Swann: That is an important question to
address, and the answer is no. The reason
is that people must understand that all the
126 countries that we rate at S&P are
rated by the same methodology. And they
go through the same rating process.
When you change the U.S. rating, that
does not necessarily imply a change to
ratings on other sovereigns.
Schachne: One of the peers that the
U.S. was compared to was France. We
have received a number of questions
Standard & Poor’s CreditWeek | August 17, 2011 60

features special report
about what S&P’s rating and outlook
is on France?
Swann: Our rating on France remains
‘AAA’ and the outlook remains stable.
Although the indebtedness ratios are
similar between the U.S. and France, the
fiscal flows are better in France.
The deficits are not as high and, again
looking at the political analysis, we believe
the French government has evidenced
more seriousness in addressing their fiscal
issues. The Sarkozy government has
recently implemented both measures to
raise revenues and to reduce expenditures.
They have also pushed through a
politically contentious pension reform,
which will both improve the long-term
fiscal sustainability of the French government
and do nothing to withdraw
stimulus in the near term. So we do see
more seriousness in addressing fiscal
issues in France than in the U.S.
Schachne: We will now hear from Laura
Feinland Katz, a managing director and
criteria officer, who will discuss our criteria
and the concept of the sovereign
ceiling, does that exist or not? Then we
will hear from representatives from our
financial institutions group to talk about
banks and government-related entities
(GREs), followed by bond insurers,
public finance, corporate ratings, and
then structured finance to wrap things up.
Laura Feinland Katz: Let’s start with
the sovereigns. The first thing to say is
that we do not think of the sovereign
rating as a ceiling.
Yet as we are about to talk about, we
have had a significant number of knockon
effects of the U.S. rating downgrade.
So why is that? Well, sovereign credit risk
is a key consideration for certain nonsov-
ereign ratings and that’s because of the
wide-ranging powers and resources of a
national government, which can affect the
financial, operating, and investment environment
of entities under its jurisdiction.
If you look at history, it indeed shows
that a sovereign default can directly result
in defaults by related borrowers as can
the indirect effect of the deterioration of
the economic and operating environment
that is typically associated with a sovereign
default. Where we rate an entity
above the sovereign, we’re making a
strong statement.
We’re expressing our view that if the sovereign
does default, there is an appreciable
likelihood that the entity or sector will
follow suit. Therefore our ratings criteria
consider these two pieces, let’s call them the
direct and indirect linkage to the sovereign,
which depend on the sector as well as the
individual credit characteristics of the issuer
or the obligor or the transaction.
Although the indebtedness ratios are similar
between the U.S. and France, the fiscal
flows are better in France.
61 www.creditweek.com
If we’re thinking about direct linkages
that’s what you would expect. We’re considering
exposures to government securities,
exposures to other obligations of the
government, or dependence on government
guarantees or other forms of government
support. In terms of indirect
linkages, we’re thinking about how deterioration
in the local macroeconomic and
operating environment would affect the
sector or the entity.
If we think about how different sectors
in the U.S. are typically affected by
these direct and indirect linkages, those
most affected by a sovereign downgrade
would be government-related entities,
or GREs. These are entities whose ratings
benefit from direct or indirect support
from the government.
Similarly, entities and transactions
that benefit from guarantees or credit
enhancements from the GREs or, of
course, from the sovereign itself would
be directly affected then. Our speakers
are going to talk more about that. Next
would be financial institutions or insurance
companies, which may have both
large direct exposures to U.S. government
securities and indirect exposures,
of course, to the effects of economic
volatility and overall investment or
lending portfolio deterioration.
We also consider the potential sovereign
rating, in fact, for state and local
governments. There is the potential for
common economic and credit environments
among the U.S. and state and
local governments to affect the ratings.
However, ratings on state, regional, or
local governments can be higher than
the sovereign rating if, in our opinion,
the individual credit characteristics of
those governments will remain stronger
than those of the sovereign during times
of economic or political stress.
Turning to the corporate sector,
depending on the industry sector or the
individual company’s financial strength,
a company may be better or less able to
withstand macroeconomic shocks or
other country-related risks. When we
think about those least exposed to sovereign
risks, those would include the
globally diversified companies or those
with export orientation, those that have
a low reliance on the public sector or
have products with relatively inelastic
domestic demand characteristics.
Finally, for securitizations, we consider
them on a case-by-case basis,
based on their exposure to direct or
indirect sovereign risks.
Schachne: So that is the criteria background
behind the various rating actions
that we did announce as a result of the
downgrades. Now we’re going to start
looking at those specific actions asset class
by asset class. We will start with financial
institutions and government-related entities
(GREs). Matt Albrecht from our
financial institutions ratings group will
talk about that asset class.
Matt Albrecht: I’ll take a look now at
the direct impact the sovereign rating

downgrade has had on financial institutions
excluding the insurance companies.
There were no immediate rating actions
on banks as a direct result of the downgrade.
This is because at this point no U.S.
bank has an issuer credit rating above the
U.S. sovereign rating. Nor does the downgrade
affect the government support we
assume for the issuer credit ratings of four
banks. We do not believe the downgrade
or the effect it has had on markets thus far
has materially impaired the ability of any
of our rated banks to access liquidity in
the market or conduct daily operations.
However, the long-term impact of a
smaller government budget and potentially
higher funding costs could have
an effect on economic growth in the
U.S. We already assume in our projections
a rather sluggish economic
recovery, but if the economy recovers
more slowly than we project or if we
do enter another recession we could
see an effect on bank ratings.
We do currently have banks rated at
the ‘AA’ level, and if the U.S. government
rating was to fall below that level
we would likely lower bank ratings for
many of the reasons Laura alluded to.
For GREs, we took a number of
rating actions as a result of the U.S.
sovereign downgrade. We lowered the
ratings on all ‘AAA’ GREs to ‘AA+’.
The list included Fannie Mae and
Freddie Mac debt, the Federal Home
Loan Bank System debt, and ‘AAA’
rated Federal Home Loan banks individually
as well as Federal Farm
System Credit debt and four debt
issues guaranteed by the National
Credit Union Administration and 126
debt issues guaranteed by the FDIC
as part of the Temporary Liquidity
Guarantee Program.
We factor varying levels of government
support into the ratings for these
institutions and issues, and according to
our GRE criteria we have lowered the
ratings to the same level as the sovereign.
If the sovereign rating were to be
lowered below the ‘AA+’ level, we
would likely lower GRE ratings again
according to our criteria.
After the sovereign rating action, we
lowered the long-term counterparty
credit ratings on the Depository Trust
Co., the National Securities Clearing
Corp., Fixed Income Clearing Corp.,
and Options Clearing Corp. to ‘AA+’
from ‘AAA’. These actions incorporate
potential incremental shifts in the
macroeconomic environment and the
long-term stability of the U.S. capital
markets as a consequence of the
decline in the creditworthiness of the
federal government.
In effect, the businesses and assets for
these clearinghouses are concentrated in
the domestic market, which constrains
their ratings. If we were to lower our
U.S. sovereign rating again, we would
likely lower our ratings on these institutions.
Ratings on principal stability
funds were not affected by the U.S.
downgrade because the U.S. short-term
rating was affirmed at ‘A-1+’.
We did, however, lower our fund
credit quality ratings on 73 funds managed
in the U.S., Europe, and Bermuda
because of their significant exposure to
U.S. Treasury and U.S. agency securities.
The ratings were lowered by up to
two notches as determined by our fund
credit quality matrix approach, which is
based on our historical ratings stability
and ratings transition studies and does
not differentiate between rating notches
within a specific category.
In summary, future ratings actions on
financial institutions will likely depend on
the U.S. sovereign rating as well as the
long-term performance of the economy
and company-specific developments.
Schachne: Could you comment a little
more on the GREs, specifically about the
impact on pass-throughs and unrated
Fannie Mae and related securities?
Albrecht: We don’t rate explicitly passthrough
securities by Ginnie Mae, Fannie
Mae, or Freddie Mac. The ratings are
implied by the market and there are two
components to the implied rating.
There is the support of the supporting or
the sponsoring entity as well as the underlying
collateral of the securities. Those are
both components of the implied rating but
in effect, we don’t actually rate them so
there is no direct effect from our actions.
Schachne: Okay. We’re going to move
on to Rodney Clark, a managing
director in our financial institutions
group. He’s going to talk about the
insurance side of the ripple effect.
Rodney Clark: As you’re all aware, on
Monday we took rating actions on 10
U.S.-based insurers related to the action
taken Friday on the rating on the U.S.
Ratings on five insurance groups
were lowered to ‘AA+’ from ‘AAA’ with
a negative outlook and five additional
insurers that were previously rated
‘AA+’ were assigned negative outlooks
consistent with the rating on the United
States. That is a direct reflection of our
criteria, and our criteria for rating
insurers above the sovereign is quite
clear that it is only in exceptional cases
that we would rate an insurance company
above the sovereign due to a
couple of issues.
First is the direct exposure to the sovereign
credit through investments in the
debt. In fact, in the case of the five
insurance companies whose ratings
were lowered to ‘AA+’ from ‘AAA’,
they had direct investment exposure
ranging on the low end of 60% of capital
invested in U.S. Treasuries and
agency debt up to 205% of capital at
the high end.
So clearly the direct exposure is significant
but perhaps more important is
the indirect exposure of those companies
to potential macroeconomic
volatility or asset performance within
their investment portfolios related to
the performance of the sovereign.
So while the downgrade of the rating of
the U.S. to ‘AA+’ from ‘AAA’ is a small
increment in credit deterioration in our
view, we still believe, and our criteria
reflect the fact, that the carry-on effects to
insurers as major investors within their
home market is significant. We do not
have in the criteria an explicit limitation
that insurers cannot be rated above the
rating of their domestic sovereign.
We have a number of exceptional
cases around the world where we have
rated insurers above the rating of their
domestic sovereigns. One key example
is Generali, based in Italy, which is
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features special report
rated one notch above the Italian sovereign
rating reflecting the fact that only
about 40% of their profits come from
Italy. In fact, they earn about as much
in Germany and France combined,
which are both ‘AAA’ sovereigns, as
they do in their home market.
Within insurance we do tend to rate
companies based in recognized financial
centers such as Ireland, Bermuda,
and the Cayman Islands potentially
above their sovereigns. In fact, most
insurance companies that are rated
higher than their sovereign rating are
based in Ireland, reflecting the fact that
the business that they are conducting
and their investments are generally
outside of that market.
They’re based there solely for regulatory
reasons. None of the 10 companies
on which we took actions on Monday
satisfy those characteristics, being all
predominantly invested in the U.S. and
conducting business in the U.S. and
therefore, in our view, linked strongly to
the performance of the U.S. economy
and assets in that economy.
Among those 10 insurers that we
took action on Monday were two bond
insurers: Assured Guaranty Corp.
(‘AA+’) whose outlook was revised to
negative from stable, as was Berkshire
Hathaway Assurance Corp. (‘AA+’).
As a result of that, the debt guaranteed
by those bond insurers has generally
also been assigned a negative outlook.
We continue our practice that
insured debt is rated based on the
higher of the rating of the bond insurer
or the underlying rating of the insured
security, and as a result of those actions
most of those issues guaranteed by
those two bond insurance groups have
been assigned a negative outlook. That
63 www.creditweek.com
includes non-U.S. issues that were
insured by Assured Guaranty’s foreign
affiliates, U.K.-based, because the ratings
on those U.K.-based entities are in
fact derived from guarantees from their
U.S. domestic parents.
Schachne: Steve Murphy, managing
director in our Public Finance group,
and his team will be addressing questions
related to public finance, including
U.S. states, municipalities, tax-exempt
housing and public power.
Steve Murphy: Given the broad
interest in U.S. Public Finance around
the U.S. downgrade, I have three senior
representatives of U.S. Public Finance
joining me today, Valerie White, senior
director and head of our Housing
group, Peter Murphy, senior director
and member of our Infrastructure group
that covers public power and trans-
Generali, based in Italy, which is rated one
notch above the Italian sovereign rating
reflecting the fact that only about 40% of
their profits come from Italy.
portation, and also Gabriel Petek who
is a senior member of our State rating
group who will be available to handle
questions on the states section.
I want to give a summary of what
actions we’ve taken so far and where we
think we’re going with respect to U.S.
Public Finance. The ratings changes as
Laura referred to, the lockstep rating
changes, which are directly related to the
U.S. rating which have been downgraded
to ‘AA+’, include defeased bonds secured
by Treasury and agency securities and
escrow, ‘AAA’ rated federal leases secured
by the U.S. full faith and credit rental
payments, certain public power entities,
certain housing entities, governmentrelated
and government-sponsored—all
went to ‘AA+’ with a negative outlook.
Specific to the state and local government
sector, on Monday we put out a
release that discussed the ability of state
and local government ratings to be
above the sovereign rating.
Following up on Laura’s remarks
regarding credit characteristic strengths,
the predictability of the framework, and
the ability to mitigate intervention by the
central governments, we do not directly
link U.S. state and local government ratings
to the U.S. sovereign rating.
Supporting this criteria, here are just a
few attributes that support this position.
In the U.S., we see a stable institutional
framework, well-established legal separation,
legal independence of individual
governments—most governments have a
high level of revenue independence.
An important point is in U.S. Public
Finance we assign issue ratings backed
by dedicated taxes, fees, pledged revenues,
etc. that include specific protections
and that are legally enforceable.
Some U.S. credits demonstrate consistent
commitment to strong, proven fiscal discipline
and it needs to be kept in line when
we talk about those that are rated ‘AAA’
and which are still rated ‘AAA’ and that’s
above the sovereign. Looking ahead, a key
occurrence for us and for everyone is the
impact of the Budget Control Act of 2011.
We’re well aware of the potential exposure
for certain state and local entities
from several directions as far as federal
spending goes, particularly in light of the
fragile economic recovery and the fact
that these cuts could complicate aspects
of state and local fiscal management.
Once the Joint Select Committee,
which is being formed as we speak,
completes its work, their recommendations,
which are due Nov. 23, will be
made public, according to their remit,
and drafted as a bill.
The vote on the bill is due by Dec. 23,
so we’ll know what we need to know as
far as where the impact on municipalities
is going to be felt.
Most credit implications, we feel, will
be linked to future federal spending.,
But there are things that we don’t know
now—specifics on expenditure reductions,
how much, obviously, to what
level, where, geographic concentration,
what types of spending will be cut, and
a key component—the time period.

After we have these facts we’ll assess
the impacts on U.S. Public Finance
credits, in both a broad and acute
nature and I’m not just talking about
the ‘AAA’s here. We’re talking about all
of our credits on a case-by-case basis.
Valerie White: Certain U.S. Public
Finance housing issues rely on guarantees,
enhancements, or insurance from
entities that either have direct or implied
support from the U.S. Government.
In housing, the ‘AAA’ issues that were
downgraded as a result of ratings
downgrades to the U.S. government,
Fannie Mae, or Freddie Mac include
issues supported by mortgage-backed
security enhancements issued by Ginnie
Mae, Fannie Mae, or Freddie Mac,
direct-pay credit instruments issues by
Fannie Mae or Freddie Mac, and issues
backed by single-asset mortgages that
are insured by the Federal Housing
Administration, also known as FHA.
In addition, the issue credit ratings
of certain public housing authorities
were downgraded. Now, as Laura
mentioned the GRE criteria earlier,
because of the previous ‘AAA’ rating
on the U.S. sovereign, these particular
public housing authorities had benefited
from a one-notch up upgrade
based on the moderate likelihood of
support of the U.S. government in
extraordinary circumstances.
Finally, ‘AAA’ housing finance agency
parity bond programs with mortgage collateral
insured by FHA were placed on
CreditWatch with negative implications.
In line with our criteria, we will be
reviewing each master bond program,
assuming that this counts as value to
the FHA-insured mortgages, and determining
if there is, in our view, sufficient
overcollateralization in those bond programs
to curb our stress assumptions.
Some of our discounts and related
stress assumptions also will be applied
to mortgage collateral with better
administration or rural housing development
insurance.
Peter Murphy: Within the infrastructure
group, we rate over 1,000 public
utilities and, for the most part, these are
monopolies that provide an essential
service and are funded by user charges.
So we do not expect any credit deterioration
in this sector related to changes in
the sovereign rating. However, two electric
utilities are government-related entities,
or GREs, as Matt Albrecht discussed,
and in conjunction with the sovereign
downgrade the debt of the Tennessee
Valley Authority (TVA) and debt supported
by payments from the Bonneville
Power Administration were lowered one
notch each to ‘AA+’ and ‘AA-’ respectively
due to the interplay between these
two GREs and the federal government.
The outlook for TVA’s bonds is negative,
while the outlook for debt supported
by Bonneville is stable, since its
stand-alone credit profile, which is
‘AA-’, could withstand a potential
decline in the sovereign rating, whereas
TVA’s would not at this point.
On the transportation side, the key
focus going forward will be on
Garvees, or grant anticipation revenue
vehicles. (Individual issuers, usually
states or state departments of
transportation, issue Garvees; federal
highway and transit aid to cities or
states is pledged to the bonds.) At this
time, we are not taking any rating
action on 25 Garvee ratings, but we
are monitoring action in Washington
regarding continuation or reauthorization
of the safety loop program.
Now due to differences in legislative
proposals from the House and the
Senate, the funding amount and the
length are unpredictable at this point.
However, we expect Congress to provide
extensions and continuing appropriations
for transportation programs
based on historical precedent. For
instance, since 2009 Congress has
extended funding of highway and
transit aid 17 times.
Ronald Barone: The sovereign downgrade
did not affect the ratings or the
stable outlooks on the six U.S. domiciled
highest-rated corporate issuers, including
Automatic Data Processing Inc. (ADP),
rated ‘AAA’, ExxonMobil Corp., rated
‘AAA’, Johnson & Johnson (J&J), also
‘AAA’, Microsoft Corp., ‘AAA’, General
Electric Co. (GE), ‘AA+’ and W.W.
Grainger Inc., also rated ‘AA+’.
As Laura had alluded to, companies
with the least exposure to country risk
include those that are globally diversified
and generally export oriented.
Given the global and diverse business
lines and significant financial strength of
Exxon Mobil, J&J, Microsoft, and GE,
we did not downgrade those entities.
They also enjoy excellent business
risk profiles with high end market
diversity, diversity of products and
service lines, a track record of solid
profitability with minimal or modest
financial risk with significant cash flow
from various business lines, and substantial
liquidity.
Although there’s no direct impact on
those credits, the ratings on these companies
may be impacted. At least a portion
of the work that they do, or the
business that they do, with the U.S. has
some minimal impact. If that should
grow, then there could be an impact on
the companies themselves. There’s also
no current impact on our ratings or ratings
outlooks on ADP (‘AAA’) and
Grainger (‘AA+’).
Although most of the revenues
from these firms come from within
the U.S. and they are less diversified
by product line and geographic business
mix than the companies I previously
mentioned, they do enjoy high
customer and end market diversification,
and their revenues held up very,
very well during the most recent
recession. They have minimal reliance
on the public sector and their set of
products is relatively demand and
elastic, again alluding to the criteria
that Laura Feinland-Katz had previously
gone over.
As was noted by other folks here, the
ratings on GREs in the U.S. corporate
sector were also lowered. These
included what we call our PX, or the
procurement exchange, companies or
entities, and that’s the Army & Air
Force Exchange Service, and we lowered
that to ‘AA-’ from ‘AA’.
We also lowered the Navy Exchange
Service Command again, to ‘AA-’ from
‘AA’, and the Marine Corps Community
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features special report
Services, again to ‘AA-’ from ‘AA’. The
last two have negative outlooks because
their stand-alone credit profile is a
minus, whereas the Army and Air Force
Exchange has a stand-alone credit profile
slightly better at ‘a’, so they have a
stable outlook.
We did not downgrade the Marines,
just the Marine PX. Again, this is
keeping in line with our criteria for government-related
entities. Additionally,
certain instruments were affected, and
it’s been noted, bonds that were supported
by the bond insurers that were
impacted had their outlooks changed
from stable to negative and defeased
bonds were also lowered to ‘AA+’
from ‘AAA’.
Now, I think more importantly, as
we move forward, the amount of cuts
that might be necessary or whatever
might come from the budget agreements
going forward, may have a
more resounding effect on corporate
issuers, including defense contractors
and Medicare providers.
There could be—if there is no agreement
by the end of the year—an additional
$500 million cut to defense contractors.
This is on top of the $300 million
that was just agreed to in the Aug. 2 deal.
Those across-the-board cuts could
certainly have an impact on the
weapons programs by many of the
defense contractors, although in
gearing up for this many of them are
starting to reduce costs and trying to
increase foreign sales to leverage additional
revenue.
The same thing with Medicare
providers—cuts to Medicare, Medicaid,
and other social programs again may
impact those doing business with the
U.S. in that regard.
Moving forward, our analysis also
includes whether a company has
“material” revenue, material meaning
20% or more from the U.S. and
assessing their ability to withstand any
cut in their revenue.
Going forward, the more concentrated
a firm’s revenues are from the U.S. government,
the more likely its credit quality
could suffer. This is the case for a
number of perhaps satellite and related
equipment providers, although most of
those are in the defense field so there’s a
balance probably there.
Same thing with certain technology
and information technology contractors
and consultants. Again, most of those
are in the defense and security agencies,
The amount of cuts that might be necessary
or whatever might come from the budget
agreements going forward, may have a more
resounding effect on corporate issuers…
65 www.creditweek.com
so they may be affected in one area but
those in Washington may decide to not
hit the defense as significantly as previously
believed.
So in addition to technology, satellite,
consulting, private contractors, and
defense firms, there could be other,
more indirect companies affected—real
estate companies, for example, if
funding for Fannie Mae and Freddie
Mac should get curtailed as part of the
budgetary reduction process; or forprofit
education.
Again, if we’re not attracting students
in the U.S. because the U.S. isn’t
backing any loans, then for-profit education
companies could suffer. Private
prisons that are contracted by the U.S.
government could be affected. Again,
there could be reductions there.
Still, at the end of the day right now
we believe most corporate borrowers
globally have stronger and more liquid
balance sheets than they did during the
recent credit crunch, and are better
positioned to weather any economic
hiccups at this point in time, given the
economy as it sits today.
Weakening of the economy again
could have a bigger impact. Right now,
they’re taking precautionary actions
probably to preserve liquidity to see
where the shakeout of the current economic
situation in the U.S. ends up.
Schachne: Before we move on to the
last asset class, which is structured
finance, we had a couple of questions
come in about public finance. One of
them was about BABs, Build America
Bonds. Steve Murphy, would you be
able to comment on that?
Murphy: I’m going to guess that the
question is around the reimbursement
which was previously from a ‘AAA’
source is now coming from a ‘AA’
source. A few points on BABs. The issue
ratings that we have on BABs are based
on the entity’s credit strengths. They
generally, if not all, are very large entities
with broad revenue and asset platforms,
and the change in the reimbursement
to ‘AA+’ from ‘AAA’ is just not
significant enough within this broad
platform to impact the rating of the
issue, if that’s what the question was.
Schachne: Yes. So moving on we will
hear from Robert Chiriani, a senior
director in our Structured Finance
group. Bob will be talking about the
impact on structured finance issues.
Robert Chiriani: Most structured
finance securities are supported by collateral
whose credit quality is not
directly linked to the sovereign rating
of the U.S.
The sovereign downgrade impacts less
than 5% of the structured finance transactions
that we rate. Since July 15, we’ve
placed 744 transactions on CreditWatch
negative after the sovereign rating was
placed on CreditWatch negative.
On Aug. 8, we published a consolidated
list of those transactions that had
been placed on CreditWatch due to the
sovereign CreditWatch placement. (See
“Ratings On Structured Finance
Transactions Remain On CreditWatch

Negative Following U.S. Sovereign
Downgrade,” published Aug. 8, 2011.)
We expect to resolve those CreditWatch
placements, either through an affirmation
of the rating or through a downgrade
over the next few weeks.
Some transactions that were previously
on CreditWatch for reasons not
related to the sovereign downgrade may
remain on CreditWatch until the nonsovereign
related issues are addressed.
The affected structured finance transactions
generally are in one of the following
categories. First, principal protected notes
which are generally collateralized by the
U.S. Treasury strips or securities issued by
a GRE; defeased transactions such as
tobacco settlement securitizations in
which all the liabilities have been offset by
Treasuries or other government obligations;
transactions with defeased loan collaterals
such as certain CMBS transactions;
and transactions with ratings
directly or partially linked to the U.S. government
such as through a guaranty from
a government agency or a GRE.
As was pointed out earlier, our criteria
does allow us to rate transactions
higher than the sovereign rating. In
fact, we currently have ratings on
structured finance transactions above
their respective sovereign ratings
around the world, and covering a
range of asset types including assetbacked
securities, residential mortgage-backed
securities, commercial
asset-backed securities, and collateralized
debt obligations.
So we are not barred from rating
these structured finance transactions as
high as ‘AAA’.
Schachne: We have a question, again
going back to public finance, about the
one-notch limit as to how many notches
a state government may be above the
U.S. sovereign rating. Can you discuss
that in a little more detail?
Murphy: This is an important point
from the question that was in the
release on Monday. There’s generally a
one-notch limit. And the reason for
that is that there are significant interdependencies,
whether economic, fed-
eral revenue, the economic performance
of locals is not completely
divorced from the economic happenings
at the federal level.
So we feel that generally it’s limited to
one notch at the current time under our
current criteria. Laura, you have anything
else to add to that?
Feinland Katz: No. We would consider
on a case-by-case basis, depending on
the linkages to the state economic environment,
the government, the federal
economic environment, linkages to payments
due from the government on a
case-by-case basis.
Murphy: Gabe, would you like to add
anything to that?
Gabriel Petek: We’re looking through
state budgets and we recognize the role
of the federal government in providing
a lot of funding, but in a lot of ways,
state governments are autonomous
actors and we continue to look at them
on their own merits and according to
our criteria.
Schachne: A related question is, is
there a specific schedule for when
S&P will be reviewing states’ ratings,
and specificly the exposure or reliance
on the U.S.?
Murphy: There’s not a specific schedule
right now. When we know the details of
the federal expense reduction plan, we
will prioritize accordingly and review
the credits.
Schachne: What is the review process
for bonds secured in whole or part by
federal highway transit funds?
Peter Murphy: There’s no change in
our approach to the Garvee ratings or
bonds secured by federal transit funds.
There are two types.
Some support highways and some
support transit systems, but our criteria
is the same for both. In general
that sector is rated fairly high. The
lowest senior lien rating we have is ‘A’,
and they go as high as ‘AAA’ because
some bonds are hybrids with some
state funds mixed in.
And we feel that as a sector in general
the coverage is very high and can withstand
some reductions in federal payments,
which is a possibility for future
federal budgets.
Schachne: A question for Bob Chiriani
on the structured finance side: Will
there be an impact on Federal Family
Education Loan Program securities as a
result of the downgrade?
Chiriani: If you go to the consolidated
list that we published on Aug. 8, you’ll
find a number of those transactions are
listed there. They are on CreditWatch
negative and we are looking to resolve
those as quickly as possible over the
next few weeks.
Schachne: For a list of the securities
that were impacted, published articles
on the downgrade and its ripple effects,
a video interview with David Beers and
John Chambers, and replays of the teleconference
calls on the sovereign and
other asset classes, please go to our website,
www. standardandpoors.com. CW
For more articles on this topic search RatingsDirect with keyword:
U.S. Downgrade
Analytical Contacts:
Nikola G. Swann
Toronto (1) 416-507-2582
Laura Feinland Katz
New York (1) 212-438-7893
Matthew Albrecht
New York 212-438-1867
Rodney A. Clark
New York (1) 212-438-7245
Steven J. Murphy
New York (1) 212-438-2066
Valerie White
New York (1) 212-438-2078
Peter V. Murphy
New York (1) 212-438-2065
Gabriel Petek
San Francisco (1) 415-371-5042
Ronald M. Barone
New York (1) 212-438-7662
Robert Chiriani
New York (1) 212-438-1271
Standard & Poor’s CreditWeek | August 17, 2011 66

features special report
67 www.creditweek.com
State And Local
Governments Face
Fiscal Challenges Under
Federal Debt Deal
Overview
■ Federal deficit reduction could complicate state and local government
fiscal management
■ Initial cuts under the Budget Control Act appear to be smaller than the revenue
losses from the Great Recession
■ Budget management may prove to be integral to maintenance of credit quality
Following the Aug. 5, 2011 downgrade of the U.S.
sovereign debt rating to ‘AA+/Negative’, Standard &
Poor’s Ratings Services said the action would not trigger
automatic rating downgrades beyond those that moved in
lockstep with the sovereign rating. We reiterated that, pursuant
to our criteria, certain state and local government ratings could
remain or be assigned at the ‘AAA’ level (see “State And Local
Government Ratings Are Not Directly Constrained By That Of
The U.S. Sovereign,” on p. 42). This does not mean there are
no credit implications from recent events, however.

Standard & Poor’s CreditWeek | August 17, 2011 68

features special report
The situation, as it is evolving, is similar
to “Hypothetical Scenario 2”, which we
contemplated in “Where U.S. Public
Finance Ratings Could Head In the
Wake Of The Federal Fiscal Crisis,” published
July 21, 2011. In it we described a
scenario in which a federal debt ceiling
agreement was reached, avoiding U.S.
Treasury defaults but resulting in a U.S.
sovereign debt rating downgrade. From
the perspective of state and local governments,
the credit implications of recent
events stem more from potential reductions
in federal funding than from the
U.S. downgrade itself.
In our opinion, the longer-term deficit
reduction framework adopted as part of
the Budget Control Act of 2011 (BCA)
could undermine the already fragile economic
recovery and complicate aspects
of state and local government fiscal
management. Either of these outcomes
could potentially weaken our view of
certain individual credit profiles of
obligors across the sector. But given the
disparate nature of state and local
economies, differing levels of reliance
on federal funding, and varying management
capabilities throughout the
U.S., we anticipate the effects on credit
quality from the BCA will likely be felt
unevenly across the sector.
Initial analysis of the terms of the
BCA suggests to us that material reductions
in federal funding to state and
local governments are unlikely to occur
before 2013. According to the BCA,
details of potential proposed federal
cuts are to be made public by Nov. 23,
2011 with a Congressional vote on the
joint special committee’s (established
under the BCA) proposals by no later
than Dec. 23, 2011 (and a final deadline
for passage of the legislation by
Jan. 15, 2012). Therefore, even if significant
cuts were to take effect starting in
fiscal 2013, this timeline provides state
and local governments advance notice,
thereby lessening liquidity risk in our
view. Furthermore, should any federal
funding reductions represent a budget
risk to state and local governments, the
cuts and potential cuts scheduled in the
BCA provide them with time to implement
budget adjustments that, in our
69 www.creditweek.com
view, could prove important in the
maintenance of their credit quality.
It is possible the federal government
will decrease funding for some programs
without commensurate changes in service
delivery mandates. Delivering on underor
unfunded mandates could be a source
of budget strain. In addition, although we
recognize that state and local governments
enjoy considerable operating
autonomy, we believe that outright withdrawal
from participation in any number
of federal programs could be politically
and administratively difficult. To the
Total Federal Spending As % Of State GDP
Fiscal year 2009; includes stimulus funds
extent state and local governments opt to
absorb and locally fund services that currently
receive federal support, we expect
the fiscal effects to vary. In part, this
reflects the range of revenue raising flexibility
(legal and political) we see among
the state and local governments.
Federal Deficit
Reduction Framework
According to the Congressional Budget
Office, the BCA is projected to reduce the
federal deficit in two phases by a total of
$2.1 trillion to $2.4 trillion through
Federal Nominal
spending state GDP % state
State Rating* Outlook (mil. $) (mil. $) GDP
Alabama AA Stable 54,674 166,819 32.8
Alaska AA+ Stable 14,215 45,861 31.0
Arizona AA- Negative 63,029 249,711 25.2
Arkansas AA Stable 27,302 98,795 27.6
California A- Stable 345,970 1,847,048 18.7
Colorado AA Stable 47,806 250,664 19.1
Connecticut AA Stable 42,589 227,550 18.7
Delaware AAA Stable 8,137 60,660 13.4
Florida AAA Stable 175,684 732,782 24.0
Georgia AAA Stable 83,917 394,117 21.3
Hawaii AA Stable 24,610 65,428 37.6
Idaho AA+ Stable 14,898 53,661 27.8
Illinois A+ Negative 116,070 631,970 18.4
Indiana AAA Stable 61,149 259,894 23.5
Iowa AAA Stable 29,369 136,062 21.6
Kansas AA+ Stable 34,705 122,544 28.3
Kentucky AA- Stable 50,012 155,789 32.1
Louisiana AA Stable 48,357 205,117 23.6
Maine AA Negative 14,242 50,039 28.5
Maryland AAA Stable 92,155 285,116 32.3
Massachusetts AA Positive 83,890 360,538 23.3
Michigan AA- Stable 92,003 369,671 24.9
Minnesota AAA Stable 45,691 258,499 17.7
Mississippi AA Stable 32,848 94,406 34.8
Missouri AAA Stable 67,942 237,955 28.6
Montana AA Stable 10,925 34,999 31.2
Nebraska AAA Stable 16,526 86,411 19.1

2021. In the first phase, deficit reduction
of $917 billion would be achieved primarily
through caps on discretionary federal
spending. In a second phase, which would
overlap the first phase, the BCA also
establishes the goal of $1.5 trillion in
additional deficit reduction over the 10year
horizon (2012 to 2021). In phase
two, specific cuts are to be agreed upon
by a 12-member joint special committee
of members of Congress and then voted
on by Congress and sent to the President.
If by Jan. 15, 2012, the joint special committee
process does not result in enacted
Total Federal Spending As % Of State GDP (continued)
Fiscal year 2009; includes stimulus funds
legislation projected to achieve at least
$1.2 trillion in deficit reduction by 2021,
automatic cuts of this amount would be
triggered. The automatic cuts of $1.2 trillion
would be across-the-board (except
certain specifically exempted programs)
and split between security and non-security
related spending. Importantly for
state governments, Medicaid and the children’s
health insurance program (CHIP)
are among the programs that would be
exempted should the across-the-board
cuts be triggered. From the standpoint of
state and local governments’ fiscal posi-
Federal Nominal
spending state GDP % state
State Rating* Outlook (mil. $) (mil. $) GDP
Nevada AA Stable 18,894 125,037 15.1
New Hampshire AA Stable 11,844 59,086 20.0
New Jersey AA- Stable 80,647 471,946 17.1
New Mexico AA+ Stable 27,472 76,871 35.7
New York AA Stable 194,975 1,094,104 17.8
North Carolina AAA Stable 84,830 407,032 20.8
North Dakota AA+ Positive 8,618 31,626 27.2
Ohio AA+ Stable 107,975 462,015 23.4
Oklahoma AA+ Stable 37,516 142,388 26.3
Oregon AA+ Stable 33,594 167,481 20.1
Pennsylvania AA Stable 135,687 546,538 24.8
Rhode Island AA Stable 11,517 47,470 24.3
South Carolina AA+ Stable 46,904 158,786 29.5
South Dakota AA+ Stable 9,499 38,255 24.8
Tennessee AA+ Positive 68,546 243,849 28.1
Texas AA+ Stable 227,108 1,146,647 19.8
Utah AAA Stable 20,702 111,301 18.6
Vermont AA+ Stable 7,092 24,625 28.8
Virginia AAA Stable 115,554 409,732 28.2
Washington AA+ Stable 66,560 331,639 20.1
West Virginia AA Stable 19,808 61,043 32.4
Wisconsin AA Stable 61,280 239,613 25.6
Wyoming AAA Stable 6,278 36,760 17.1
Average 24.6
Min 13.4
Max 37.6
*Ratings as of Aug. 17, 2011.
Sources: U.S. Census Bureau, Consolidated Federal Funds Report for Fiscal Year 2009 (table 13); 2009 State GDP - Bureau of
Economic Analysis.
tions, the structure of the automatic
trigger cuts have potential to be more
favorable than cuts that could derive from
the joint special committee recommendations.
It is possible the joint special committee
could recommend approaches to
deficit reduction that more directly—and
negatively—affect state and local government
budgets than would the trigger cuts.
Analytic Implications Of The
Budget Control Act To States
Cash flow
Following the recent increase to the federal
debt limit, we expect federal cash disbursements
to flow to payees as scheduled,
including those to state and local
governments. Thus, we do not anticipate
cash flow disruptions for states with
regard to their receipt of federal aid. As
we understand it, though, states had been
actively developing contingency plans in
the event an agreement had not been
reached and the federal government began
prioritizing its disbursements. It was
unclear where important state aid, such as
that for Medicaid, would have ranked
among federal priorities. According to our
initial survey, most states had cash flow
capacity to continue to fund operations as
budgeted for periods ranging from several
weeks to months. In our ongoing review
of states’ creditworthiness, we will consider
cash management in advance of any
federal spending reductions that we
believe could strain states’ liquidity.
Tax reform and market liquidity
We do not anticipate material disruption
to the market for most municipal bonds as
a result of the BCA. However, should the
federal tax code be reformed it is possible
that the municipal bond market could be
affected. Current law includes expiration
of the Bush-era reduced marginal tax
rates. If the tax cuts (passed in 2001 and
2003) were allowed to expire, marginal
federal income tax rates would increase on
Jan. 1, 2013. Under such a scenario, the
tax exemption on interest income from
investments in tax-exempt municipal
bonds could increase in value to investors
subject to federal income taxes. This could
exert downward pressure on interest rates
faced by municipal issuers.
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Instead of allowing marginal tax rates to
increase, some members of Congress have
signaled support for reducing tax exemptions
and deductions that currently exist in
the tax code. One such reform would
reduce or eliminate the tax-exempt status
of interest earnings on municipal bonds,
which in our view would likely increase
the interest costs to municipal issuers.
The budgetary implications to the states of
the BCA rest to a considerable extent on the
outcome of the deficit reduction process
undertaken by the joint special committee.
Other potential tax reform proposals
that some members of Congress and other
public officials have mentioned include
eliminating the mortgage interest tax
deduction. We believe such a reform could
have far-reaching effects on the real estate
market, which is already suffering from an
overhang of supply built up during the
housing boom of the mid 2000s.
Elimination of the tax deductibility of
mortgage interest would effectively make
housing less affordable. Under this scenario,
we would anticipate negative effects
on home prices—which would translate to
lower assessed values, albeit with a lag due
to the assessment process. Ultimately, this
chain of events could have a negative
effect on property and real estate related
tax revenues.
Changes to the tax law intended to
generate higher federal revenues would,
in our view, presumably need to be
addressed as part of the joint special
committee process or by Congress as
distinct tax reform legislation since the
automatic deficit reduction provisions
of the BCA do not include increased tax
revenues (and involve only spending
adjustments and interest savings).
Budgetary: Deficit reduction
in two phases
Phase one: caps on discretionary
spending. The budgetary implications to
the states of the BCA rest to a consider-
able extent on the outcome of the deficit
reduction process undertaken by the joint
special committee. The immediate
spending caps associated with phase one
reduce discretionary outlays by $756 billion
and, when coupled with interest savings
on debt, are projected to result in
$917 billion of deficit reduction over 10
years. But much of the reduced spending
for this phase is back-loaded. Of the total
discretionary spending subject to the cap,
there is $25 billion and $46 billion in
reduced spending in fiscal 2012 and
2013, respectively—less than 10% of the
total planned reduced spending. These
reductions, moreover, are relative to current-law
baseline projections, which are
scheduled to increase over time. Relative
to the prior year, the only outright
spending decline ($7 billion) occurs in
fiscal 2012—with $2 billion of reductions
to non-security spending and $5 billion to
security-related spending programs.
Hypothetically, even if all of the cuts were
imposed on states, the reduction would
equal 1.5% of federal funds (and just
0.6% of total revenue) to state governments
(at 2009 funding levels). In any
event, we expect that state budgets will
bear much less than the entire burden of
the reduced spending. In fiscal years 2012
and 2013, for example, the BCA specifies
the split between reduced security and
non-security discretionary spending, but
is silent for the years from 2014 to 2021.
Although the loss of any amount of
federal funds may impede states’ efforts
to maintain fiscal balance, particularly
in light of the slow economic recovery,
states have experienced much larger
revenue losses than this in recent years.
Total state tax revenues declined 8.6%
in 2009 compared to 2008 as a result of
the recession. The revenue declines were
partially offset by increased federal
funding which, especially in the case of
certain public welfare programs, functions
as an automatic stabilizer to the
economy. In addition, during the second
quarter of 2009, increased federal funds
provided under the American Recovery
and Reinvestment Act (ARRA) began to
be disbursed to the states. However,
although the increased federal funding
($55 billion in 2009) helped, it did not

completely make up for the lost state
tax revenues ($67 billion). Nonetheless,
even as the revenue declines among the
states contributed to budget crises for
some of them, we differentiated this
from outright debt crises among states,
even in cases where fiscal strain factored
into credit rating downgrades.
This was due to the states’ taking corrective
budget actions—in many
instances, in mid-fiscal year.
Phase two: alternative scenarios.
Phase two of the BCA envisions deficit
reduction ranging from $1.2 trillion to
$1.5 trillion through 2021 achieved via
one of two contemplated scenarios. For
the states, much depends on the efficacy
of the joint special committee, whose
goal, pursuant to the BCA, is $1.5 trillion
in deficit reduction. Under the
BCA, the joint special committee will
recommend a deficit reduction plan by
Nov. 23, 2011 with a Congressional
vote by Dec. 23, 2011. If this process
does not materialize in the enactment of
deficit reduction legislation, across-theboard
cuts, or funding “sequestration,”
would be triggered automatically.
Because the trigger cuts exempt certain
programs important to states, this scenario
could be more favorable to state
and local government finances than
potential cuts that could emerge under
the joint special committee process.
Phase two: no deficit reduction legislation
(automatic trigger cuts). If the joint
special committee process does not result
in enacted deficit reduction legislation,
the automatic trigger cuts would total
$1.2 trillion over 10 years. Compared to
the $756 billion in reduced discretionary
spending of phase one, these spending
reductions are, according to the BCA,
more evenly dispersed across the
horizon. However, the BCA exempts
specific programs, including Medicaid
and CHIP, thereby shielding prominent
parts of state budgets.
Nonetheless, given the interdependence
between the states and the federal
government, with federal sources of revenue
comprising about 32% of total
state revenues (2009 data, U.S. Census
Bureau), we expect reduced funds for
states to be an unavoidable outcome at
least to some degree should the automatic
cuts be triggered. In a scenario
where the across-the-board cuts were
triggered, state grants and pass-through
funds could experience large reductions.
However, states would know by Jan. 15,
2012 whether the sequestration cuts are
triggered, nearly one year before they
would be implemented in January 2013.
This timeline provides some opportunity
for states to accommodate the cuts from
a budget management perspective. By
and large, this reduced federal funding
would not affect states’ discretionary
revenue. Therefore, if across-the-board
cuts were triggered, we believe that the
reduced aid to states might not have a
commensurately negative effect on
states’ fiscal positions. In short, we
expect that reduced federal funding
could be met by states with programmatic
cuts in many areas that have been
heretofore funded with federal dollars.
As we noted earlier, to the extent states
decide to continue funding such programs
on their own, fiscal tradeoffs will
be involved. We understand that some
mandates, such as for certain educationrelated
programs, would likely remain
in place and represent an increased fiscal
responsibility for states. Whether and
how states manage any potential federal
cuts could play a role in our review of
budget management as a part of the
larger rating process.
Phase two: deficit reduction legislation.
If the joint special committee
process achieves enactment of deficit
reduction legislation, in our view state
finances could be more vulnerable to
potential changes in the federal-state
funding relationship. Entitlement programs
represent some of the biggest
drivers of the federal government’s longterm
projected fiscal deficit. With wide
latitude regarding how to shape deficit
reduction, the joint special committee can
recommend changes in entitlement programs,
with Medicaid representing the
most significant from the states’ perspective.
The federal and state governments
jointly finance Medicaid but each state
manages it individually. According to the
Centers for Medicare and Medicaid
Services, total governmental spending on
Standard & Poor’s CreditWeek | August 17, 2011 72

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Medicaid was $374 billion in 2009
(2.7% of GDP), of which the federal government
funded $247 billion. (Federal
funding for public welfare programs,
including Medicaid, increased 16.3% in
2009 as a result of the ARRA. In 2008,
total Medicaid spending was $343.1 billion
with federal funds comprising
$202.4 billion of this). If federal funding
for Medicaid were converted to block
grants or there were changes to the federal
medical assistance percentage (the
formula upon which federal matching is
determined) that lowered federal reimbursements,
as long as states continue to
participate in the program they could
incur greater funding responsibility
unless they were also granted increased
flexibility regarding service requirements.
State and local governments have a strong
track record of active budget management
when it comes to responding to a
constrained revenue environment.
Changed budget environment
under any scenario
Following adoption of the BCA, we
believe that, under any scenario, states
can likely expect reduced federal funding,
amounting to an impediment to their
ability to maintain fiscal balance over the
ensuing 10 years. But we note that, in our
view, state and local governments have a
strong track record of active budget management
when it comes to responding to
a constrained revenue environment. For
example, according to the Bureau of
Labor Statistics, as of June 2011, state
and local governments had shed
499,000 jobs since June 2008. In the
aggregate, payroll reductions are a part
of overall spending cuts by state and
local governments. Data from the
Bureau of Economic Analysis indicate
that total state and local consumption
expenditures and gross investment
declined 3.3% in the first quarter of
2011 after dropping by 2.6% in the
fourth quarter of 2010.
These spending cuts and job reductions
provide fiscal drag which could
negatively impact the nation’s economic
recovery, but paradoxically they help
preserve the credit quality of individual
obligors. The workforce reductions represent
the difficult choices we have
observed and referenced in prior comments,
and they are an integral part of
most governments’ budget-balancing
strategies. Pursuant to our rating criteria,
in evaluating credit quality, we will
continue to consider how effectively
state and local governments navigate a
new era of reduced federal funding.
Economic. Federal government
spending is important to both the
national and state level economies.
Based on 2009 figures, federal spending
(including payments to individuals and
governments) comprised 25% of state
gross domestic product on average,
ranging from as little as 13% to as
much as 38%, depending upon the state
(see table). Federal economic stimulus
spending associated with the ARRA
provided countercyclical support to
states during the depths of the recent
recession. Whereas total state tax revenues
shrank 8.6%, federal grants to
states increased 13% from 2008 to
2009. The federal spending cuts contemplated
in the BCA are in addition to
the phase-out of federal stimulus
funding and could have a contractionary
effect on the national and state
economies. The discretionary spending
caps result in relatively modest cuts in
the initial years compared to the
national GDP. But, according to IHS
GlobalInsight, this fiscal contraction
could reduce GDP growth by 0.2%. On
top of an already-fragile recovery, these
federal cuts could therefore contribute
to even slower economic growth. Two
full years after the official end of the
2007 recession, consumer sentiment,
after recovering somewhat earlier in
2011, has receded and fell sharply in
July to its lowest level since May 1980,
according to IHS GlobalInsight. And,
19 states still have unemployment rates
above 9.1%. Conversely, this also
means 31 states have unemployment
rates below the nation’s and serves as an

example of the disparate state and local
economies that comprise the United
States. We will therefore continue to
evaluate each state and local obligor in
its own economic context.
Potential Analytic Implications
Of Debt Ceiling Agreement To
Local Governments
Cash flow and budgets
Historically, local governments have
tended to rely on a combination of
locally derived revenues (property or
sales taxes) and state aid or state shared
revenues. For cash flow planning purposes,
fiscal 2012 began favorably for
local governments since all but one state
had an enacted budget by the start of
the fiscal year. Local governments relied
on federal funding for less than 4% of
total revenues in 2008. And, while local
governments receive higher amounts of
federal aid indirectly (via their state
governments), as mentioned above, we
expect federal funds to be disbursed in a
timely manner and as scheduled. Future
spending cuts associated with the BCA
may present budgetary complications,
but we do not anticipate unforeseen
cash flow disruptions for local governments
as a result of the agreement.
Economy
We expect any negative economic
impact from reduced federal spending
to affect local governments by constraining
further an already-slow
recovery, similar to the effect we expect
on state economies. Special projects
funded by earmarks or discretionary
federal appropriations could be jeopardized.
We believe that our ratings of
obligors with economic exposure to federal
military base realignment and closure
offer an analytic paradigm. In
practice, many communities have successfully
redeveloped previous military
bases resulting in less economic damage
than initial estimates.
Economic And Fiscal Horizon
Underscores Importance Of
Financial Management
We see a complicated credit landscape
on the horizon for state and local gov-
ernments now that they have weathered
several years of difficult economics.
The federal debt ceiling
increase averted the potential for
acute liquidity shortfalls that could
have arisen if the federal government
had shut off significant amounts of
disbursements to state and local governments.
However, while enactment
of the BCA may have mitigated nearterm
liquidity risk (associated with
federal funds), we believe that
medium-term budgetary and economic
risks for state and local governments
persist. With an already tepid economic
recovery, the additional reduction
of federal funds could fuel
retrenchment among consumers.
This said, we expect many state and
local governments to be better-poised
to manage federal cuts to their grant
funding than the recessionary-based
revenue declines of 2008 and 2009.
Compared to the revenue losses from
the Great Recession, the initial federal
cuts appear to be smaller in magnitude.
And, further potential cuts
that Congress and the President may
approve will be preceded by advance
notice based on the timeline laid out
in the BCA. But considering that
many governments’ finances are still
in the early stages of fiscal repair
from the recession, the BCA offers
little respite from further emphasis on
budget austerity. In our view, the
additional budget strain from the
potential federal cuts underscore the
importance of the financial management
components of our criteria. CW
Olivia Bizovi provided research
assistance.
For more articles on this topic search RatingsDirect with keyword:
State and Local Governments
Analytical Contacts:
Gabriel Petek
San Francisco (1) 415-371-5042
Steven J. Murphy
New York (1) 212-438-2066
Robin Prunty
New York (1) 212-438-2081
John Sugden-Castillo
New York (1) 212-438-1678
Standard & Poor’s CreditWeek | August 17, 2011 74

contacts
Global Ratings Network
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