Stora Enso Oyj Primary Credit Analyst: Gustav Liedgren, Stockholm (46) 8-440-5916; gustav.liedgren@standardandpoors.com Secondary Contact: Terence O Smiyan, London (44) 20-7176-6304; terence.smiyan@standardandpoors.com Recovery Analyst: Tuomas E Ekholm, CFA, Frankfurt (49) 69-33-999-123; tuomas.ekholm@standardandpoors.com Research Assistant: Akshat D Adukia, Mumbai Table Of Contents Rationale Outlook Standard & Poor's Base-Case Scenario Company Description Business Risk Financial Risk Liquidity Other Modifiers Ratings Score Snapshot Recovery Analysis Reconciliation WWW.STANDARDANDPOORS.COM/RATINGSDIRECT MARCH 27, 2015 1 1391222 | 301444691 Table Of Contents (cont.) Related Criteria And Research WWW.STANDARDANDPOORS.COM/RATINGSDIRECT MARCH 27, 2015 2 1391222 | 301444691 Stora Enso Oyj Business Risk: FAIR CORPORATE CREDIT RATING Vulnerable Excellent bb bb bb BB/Stable/B Financial Risk: SIGNIFICANT Highly leveraged Minimal Anchor Modifiers Group/Gov't Nordic Regional Scale --/--/K-4 Rationale Business Risk: Fair Financial Risk: Significant • Exposure to the highly cyclical forest and paper products industry, characterized by intense competition, recurring periods of overcapacity, high sensitivity to raw material costs, and poor pricing power. • Material exposure to graphic paper (newsprint, magazine, and fine paper represents around 40% of sales), which is facing a structural decline in demand. • Significant exposure to mature European economies. • Strong and improving position in the relatively attractive consumer packaging segment. • Well-diversified asset and product portfolio and strong geographic reach. • Cyclical operational cash flow generation. • Highly capital-intensive operations and aggressive expansion investments. • Ongoing dividend payments during period of high capital expenditure (capex). • "Strong" liquidity. • Ability and willingness to reduce capex to preserve cash. Outlook: Stable The stable outlook on Finnish forest and paper products group Stora Enso Oyj (Stora Enso) reflects our view that Stora Enso's profitability will gradually improve, leading to broadly stable credit metrics. We forecast that Stora Enso's Standard & Poor's-adjusted ratio of funds from operations (FFO) to debt will be about 20%, and adjusted debt to EBITDA less than 4x in 2015, levels we regard as commensurate with the 'BB' long-term rating. WWW.STANDARDANDPOORS.COM/RATINGSDIRECT MARCH 27, 2015 3 1391222 | 301444691 Stora Enso Oyj Downside scenario We could lower the long-term rating if weakening market conditions, combined with higher-than-expected investments, led to a deterioration of Stora Enso's credit metrics. For example, we would consider ratios of FFO to debt of about 15% and debt to EBITDA of more than 4x, for an extended period of time and with no scope for improvement, as incommensurate with the 'BB' long-term rating. Furthermore, we think the group's credit quality could weaken if its financial policy became more aggressive. This could occur as a result of large, debt-financed acquisitions or exceptionally shareholder-friendly measures, although we think these are currently unlikely. Upside scenario An upgrade is highly unlikely in the coming 12 months, in our view, due to still-difficult European paper markets and the group's investment ambitions. Over the longer term, we could raise the long-term rating if we saw substantial and sustained improvements in Stora Enso's profitability and cash flow generation to the extent that we could revise our assessment of the group's business risk profile upward, or if FFO to debt rose to and remained above 30%. Standard & Poor's Base-Case Scenario Assumptions • Economic recovery to remain fragile in 2015 and 2016. • Revenues to grow in the low-single-digit range in 2015 and 2016, as volumes and prices improve in the pulp, wood, and packaging divisions, while the paper division remains weak. • EBITDA margin to gradually improve given the ongoing cost-cutting measures and growth investments. • Capex of €780 million-€840 million in 2015. • Stable dividend payouts and no large cash outlays on mergers and acquisitions. Key Metrics 2014A 2015E 2016E EBITDA margin (%)* Debt/EBITDA (x)* FFO/debt (%)* 12.5 13-14 13-15 3.8 3-3.5 3-3.5 19.3 20-23 24-27 *Fully Standard & Poor's-adjusted. A--Actual. E--Estimate. Company Description With sales of €10.2 billion in 2014, Stora Enso is among the largest diversified forest product companies globally. It holds leading positions in newsprint, magazine paper, fine paper, and consumer and industrial packaging board. Operations also include specialty paper, pulp production--primarily used in the group's own mills--and wood supply and wood products. The group has production facilities in several countries, including Finland, Sweden, Germany, Belgium, Brazil, Uruguay, and China. Production and sales are focused on Europe, but the group's strategy is to target growth in emerging markets such as China and South America. WWW.STANDARDANDPOORS.COM/RATINGSDIRECT MARCH 27, 2015 4 1391222 | 301444691 Stora Enso Oyj Stora Enso is domiciled in Finland, and is listed on the Helsinki and Stockholm stock exchanges. The Finnish state holds 25% of the voting rights, but we do not factor state support into the ratings. Business Risk: Fair Our assessment of Stora Enso's business risk profile reflects the group's significant exposure to the highly cyclical European pulp and paper markets, characterized by demand fluctuations resulting from economic activity, recurring periods of overcapacity, high sensitivity to the cost of raw materials, and limited pass-through of costs because of poor pricing power. Stora Enso is also materially exposed to graphic paper (about 40% of group sales and around 21% of operational EBIT in 2014), which is cyclical and in structural decline due to ongoing migration to electronic media. Despite recent capacity closures in Europe, there is still overcapacity in certain paper grades, which in our view makes sustained price increases difficult to implement. In addition, we consider Stora Enso's large proportion of sales to low-growth European markets (about 75% in 2014) a further constraint. These weaknesses are mitigated by Stora Enso's strong positions within the more stable packaging materials market, and its large size and scope as one of the world's largest forest and paper products companies, with a well-diversified asset and product portfolio. A further relative strength is management's clear strategy to improve the business portfolio through investments in markets and product segments with attractive growth opportunities, such as consumer packaging in Asia and plantation-based pulp in South America, which should lead to an improved product mix with around 30% of sales coming from paper once the investments have been ramped up. Although we acknowledge that there are significant implementation risks with the investments Stora Enso is currently undertaking, we think that its business risk profile could improve in the next three-to-four years if investments are realized as planned. We also think that the ongoing tough cost-cutting have the potential to improve efficiency and competitiveness in Stora Enso's mature business segments. S&P Base-Case Operating Scenario • Graphic paper demand to continue its downward trend by falling around 3%-5% annually over 2015-2016 in Europe due to digital substitution. At the same time, we expect demand for Stora Enso's packaging products to remain robust in 2015. The paperboard mill in China, which is scheduled to come online in 2016, will add to volume growth. • Pulp volumes to grow significantly in 2015 when the Montes del Plata pulp mill in Uruguay operates at full capacity, with stable volume growth thereafter. • The pricing environment to remain largely stable for paper and paperboard in Europe and also for both softwood and hardwood pulp. Peer comparison Stora Enso's peer group consists mainly of other large integrated forest and paper products companies. Its "fair" business risk profile is on the same level as that of Sappi Ltd., and weaker than the "satisfactory" business risk profiles of Smurfit Kappa Group PLC, International Paper Co., and UPM-Kymmene Corp. Smurfit Kappa and International Paper have more favorable product and geographic portfolios than Stora Enso, as the vast majority of their sales derive from paper-based packaging and they have a larger exposure to emerging markets than Stora Enso. A large part of UPM-Kymmene's earnings derive from the relatively stable energy segment and very WWW.STANDARDANDPOORS.COM/RATINGSDIRECT MARCH 27, 2015 5 1391222 | 301444691 Stora Enso Oyj profitable pulp operations, which leads to more stable operations over the cycle. Stora Enso's "significant" financial risk profile is on the same level as that of Smurfit Kappa and UPM-Kymmene, although Stora Enso's credit metrics have recently been weaker than those of UPM-Kymmene. International Paper has stronger and Sappi weaker credit metrics than Stora Enso, resulting in overall higher and lower ratings than Stora Enso, respectively. Table 1 Stora Enso Oyj Peer Comparison Stora Enso Oyj UPM-Kymmene Corp. Sappi Ltd. Smurfit Kappa Group PLC International Paper Co. BB/Stable/B BB+/Stable/B BB-/Stable/B BB+/Stable/-- BBB/Stable/NR Business risk profile Fair Satisfactory Fair Satisfactory Satisfactory Financial risk profile Significant Significant Aggressive Significant Intermediate bb bb+ bb- bb+ bbb -- -- -- -- -- Rating as of March 26, 2015 Anchor Modifiers --Average of past three fiscal years-(Mil. €) Revenues 10,530.3 10,174.7 4,703.0 7,791.7 20,576.1 EBITDA 1,219.2 1,202.7 589.0 1,123.7 3,043.5 Funds from operations (FFO) 918.4 985.1 393.9 734.8 2,446.7 Net income from cont. oper. 175.3 (91.7) 17.8 223.0 672.4 Cash flow from operations 932.6 1,079.1 310.3 701.1 2,367.0 Capital expenditures 679.7 362.0 304.3 377.0 995.9 Free operating cash flow 252.9 717.1 5.9 324.1 1,371.1 Discretionary cash flow 12.6 400.1 5.9 242.8 946.0 250.3 100.0 98.3 97.5 384.9 Debt 4,672.2 3,936.2 2,108.7 3,763.9 8,871.0 Equity 5,457.3 7,497.5 949.5 2,464.7 5,319.2 EBITDA margin (%) 11.6 11.8 12.5 14.4 14.8 Return on capital (%) 6.3 4.6 7.6 10.7 8.6 EBITDA interest coverage (x) 4.6 11.0 3.2 3.8 4.3 FFO cash int. cov. (X) 5.7 18.1 4.1 4.4 5.4 Debt/EBITDA (x) 3.8 3.3 3.6 3.3 2.9 FFO/debt (%) 19.7 25.0 18.7 19.5 27.9 Cash flow from operations/debt (%) 20.0 27.4 14.7 18.6 26.7 Free operating cash flow/debt (%) 5.4 18.2 0.2 8.6 15.5 Discretionary cash flow/debt (%) 0.3 10.2 0.2 6.5 10.7 Cash and short-term investments Adjusted ratios WWW.STANDARDANDPOORS.COM/RATINGSDIRECT MARCH 27, 2015 6 1391222 | 301444691 Stora Enso Oyj Financial Risk : Significant Stora Enso's financial risk profile is constrained by its highly cyclical cash flow generation, stemming from industry cycles and working capital use; and by its highly capital-intensive operations, with long lead times for new investments. The group is currently pursuing an aggressive investment plan to reposition itself towards growth segments within the forest products sector. Its pulp mill in Uruguay commenced operations in 2014, while its packaging mill in China is due to come online in 2016. Hence we believe that Stora Enso's credit metrics could improve from 2016, given the increased earnings and cash flow generation potential of the group's current investment programs. However, delays or cost overruns relating to the investment programs, coupled with worsening operating conditions in the existing divisions, could put additional pressure on the credit metrics, and, in turn, on the ratings. These weaknesses are offset by Stora Enso's willingness to reduce capex, evident from its decision in 2013 to construct its integrated packaging mill in Guangxi in China in two stages, thereby reducing investments in the near term. We believe that the group's prefunding of investments, diverse funding base, and prudent liquidity management further mitigate its relatively high debt leverage and at times weak cash flow generation. S&P Base-Case Cash Flow And Capital Structure Scenario • Capex of around €780 million-€840 million, in line with management guidance. • Stable dividend payments until at least 2016. • Possible additional working capital inflows if more paper machines are closed or sold. Financial summary Table 2 Stora Enso Oyj Financial Summary --Fiscal year ended Dec. 31-(Mil. €) Rating history 2014 2013 2012 2011 2010 BB/Stable/B BB/Stable/B BB/Negative/B BB/Stable/B BB/Positive/B Revenues 10,213.0 10,563.0 10,815.0 10,964.9 10,296.9 EBITDA 1,272.5 1,073.0 1,312.1 1,350.5 1,272.8 941.9 778.5 1,034.9 1,115.9 1,033.0 99.0 (53.0) 480.0 339.7 766.0 757.8 1,036.1 1,003.9 746.0 837.4 Capital expenditures 770.0 717.0 552.0 407.7 388.9 Free operating cash flow (12.2) 319.1 451.9 338.3 448.5 Discretionary cash flow (249.2) 75.1 211.9 137.5 289.6 250.0 251.0 250.0 250.0 250.0 Debt 4,867.7 4,395.5 4,753.3 4,289.2 3,835.5 Equity 5,237.0 5,273.0 5,862.0 5,959.3 6,253.9 EBITDA margin (%) 12.5 10.2 12.1 12.3 12.4 Return on capital (%) 7.6 4.8 6.6 8.3 8.2 EBITDA interest coverage (x) 4.6 3.8 5.5 7.2 8.5 FFO cash int. cov. (x) 5.6 4.6 7.2 9.9 9.5 Funds from operations (FFO) Net income from continuing operations Cash flow from operations Cash and short-term investments Adjusted ratios WWW.STANDARDANDPOORS.COM/RATINGSDIRECT MARCH 27, 2015 7 1391222 | 301444691 Stora Enso Oyj Table 2 Stora Enso Oyj Financial Summary (cont.) Debt/EBITDA (x) 3.8 4.1 3.6 3.2 3.0 FFO/debt (%) 19.3 17.7 21.8 26.0 26.9 Cash flow from operations/debt (%) 15.6 23.6 21.1 17.4 21.8 Free operating cash flow/debt (%) (0.3) 7.3 9.5 7.9 11.7 Discretionary cash flow/debt (%) (5.1) 1.7 4.5 3.2 7.6 N.M. - Not Meaningful. Liquidity : Strong The short-term rating is 'B'. We assess Stora Enso's liquidity as "strong," as defined in our criteria. We expect the group's sources of liquidity to substantially exceed the uses over the 12-18 months from Jan. 1, 2015. Furthermore, the group's loan documentation is free from restrictive financial covenants; it has a solid relationship with its banks; and it has demonstrated access to the debt capital markets. The group also refinanced its €700 million revolving credit facility (RCF) in 2014, extending the maturity date to January 2018 from January 2015 previously. Principal Liquidity Sources • An available cash balance of about €1.4 billion as of Dec. 31, 2014; • Access to an undrawn committed RCF of €700 million, maturing in January 2018 (free of financial covenants that would restrict Stora Enso from drawing on the facility), and $275 million available under its $460 million funding facility for the Guangxi investment; and • Our forecast of unadjusted FFO of €1.1 billion-€1.2 billion in 2015 and 2016. Principal Liquidity Uses • • • • Contractual debt maturities of about €1.1 billion in 2015 and about €0.7 billion in 2016; Capex of €780 million-€840 million in 2015, as indicated by management; Estimated dividends of about €240 million; and Limited working capital and acquisition outflows. Debt maturities (Mil. €) 2015: 1,292 2016: 854 2017: 772 2018: 826 2019: 726 Thereafter 1,171 WWW.STANDARDANDPOORS.COM/RATINGSDIRECT MARCH 27, 2015 8 1391222 | 301444691 Stora Enso Oyj Other Modifiers The modifiers do not have any impact on the rating. Ratings Score Snapshot Corporate Credit Rating BB/Stable/B Business risk: Fair • Country risk: Low • Industry risk: Moderately high • Competitive position: Fair Financial risk: Significant • Cash flow/Leverage: Significant Anchor: bb Modifiers • Diversification/Portfolio effect: Neutral (no impact) • Capital structure: Neutral (no impact) • Financial policy: Neutral (no impact) • Liquidity: Strong (no impact) • Management and governance: Satisfactory (no impact) • Comparable rating analysis: Neutral (no impact) Recovery Analysis Key analytical factors • The issue rating on Stora Enso's senior unsecured debt is 'BB', with a recovery rating of '4' indicating our expectation of average recovery (30%-50%) in an event of a payment default. Recovery expectations are at the higher end of the 30%-50% range. • Our issue and recovery ratings on the unsecured debt are supported by our valuation of the company as a going-concern, driven by its leading market positions, modern and efficient asset base, broad product and geographic diversity, and significant vertical integration, as well as Finland's favourable insolvency regime. • The recovery rating is constrained by the unsecured nature of the notes and the substantial priority liabilities and volume of unsecured debt in the waterfall. • In our hypothetical scenario, we believe that Stora Enso would face pressure on profitability resulting from oversupply, pressure on prices, and input cost volatility. WWW.STANDARDANDPOORS.COM/RATINGSDIRECT MARCH 27, 2015 9 1391222 | 301444691 Stora Enso Oyj Simulated default assumptions • • • • Simulated year of default: 2018 EBITDA at default: €645 million Implied enterprise value multiple: 6.0x Jurisdiction: Finland Simplified waterfall • Stressed enterprise value at default: €3.9 billion • Administrative costs: about €310 million • Net value available to creditors: €3.56 billion • Priority claims: €1.6 billion* • Unsecured debt claims: €4.6 billion ** • --Recovery expectation 30%-50% (higher end of range) *Includes financial lease, factoring program and pension related liabilities considered as priority, as well as bank debt at subsidiaries structurally senior to parent company unsecured debt. **Includes six months' prepetition interest. Revolving credit facility is assumed 85% drawn at default. Reconciliation Table 3 Reconciliation Of Stora Enso Oyj Reported Amounts With Standard & Poor's Adjusted Amounts (Mil. €) --Fiscal year ended Dec. 31, 2014-Stora Enso Oyj reported amounts Shareholders' Debt equity Revenues EBITDA Reported Operating Interest income expense Cash flow from Dividends Capital EBITDA operations paid expenditures 4,894 5,070 10,213 1,280 400 211 1,280 888 237 787 Interest expense (reported) -- -- -- -- -- -- (211) -- -- -- Interest income (reported) -- -- -- -- -- -- 22 -- -- -- Current tax expense (reported) -- -- -- -- -- -- (79) -- -- -- Trade receivables securitizations 170 -- -- -- -- 5 (5) (145) -- -- Operating leases 550 -- -- 76 32 32 43 43 -- -- Postretirement benefit obligations/deferred compensation 429 -- -- (7) (7) 11 (16) (12) -- -- (1,196) -- -- -- -- -- -- -- -- -- -- -- -- -- -- 17 (17) (17) -- (17) Standard & Poor's adjustments Surplus cash Capitalized interest WWW.STANDARDANDPOORS.COM/RATINGSDIRECT MARCH 27, 2015 10 1391222 | 301444691 Stora Enso Oyj Table 3 Reconciliation Of Stora Enso Oyj Reported Amounts With Standard & Poor's Adjusted Amounts (Mil. €) (cont.) Share-based compensation expense -- -- -- 6 -- -- 6 -- -- -- Dividends received from equity investments -- -- -- 19 -- -- 19 -- -- -- Non-operating income (expense) -- -- -- -- 22 -- -- -- -- -- Non-controlling Interest/Minority interest -- 167 -- -- -- -- -- -- -- -- Debt - Contingent considerations 21 -- -- -- -- -- -- -- -- -- EBITDA - Income (expense) of unconsolidated companies -- -- -- (87) (87) -- (87) -- -- -- EBITDA Gain/(Loss) on disposals of PP&E -- -- -- (14) (14) -- (14) -- -- -- D&A - Asset Valuation gains/(losses) -- -- -- -- 114 -- -- -- -- -- D&A - Impairment charges/(reversals) -- -- -- -- 228 -- -- -- -- -- EBIT - Income (expense) of unconsolidated companies -- -- -- -- 87 -- -- -- -- -- (26) 167 - (8) 375 65 (338) (130) - (17) Total adjustments Standard & Poor's adjusted amounts Debt Adjusted 4,868 Equity Revenues EBITDA 5,237 10,213 1,273 Funds Cash flow Interest from from Dividends Capital EBIT expense operations operations paid expenditures 775 276 942 758 237 Related Criteria And Research Related Criteria • • • • • • • • Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Dec. 16, 2014 Key Credit Factors For The Forest And Paper Products Industry, Feb. 12, 2014 Corporate Methodology, Nov. 19, 2013 Methodology: Industry Risk, Nov. 19, 2013 Country Risk Assessment Methodology And Assumptions, Nov. 19, 2013 Corporate Methodology: Ratios And Adjustments, Nov. 19, 2013 Methodology: Management And Governance Credit Factors For Corporate Entities And Insurers, Nov. 13, 2012 2008 Corporate Criteria: Rating Each Issue, April 15, 2008 WWW.STANDARDANDPOORS.COM/RATINGSDIRECT MARCH 27, 2015 11 1391222 | 301444691 770 Stora Enso Oyj Related Research • Top 10 Global Investor Questions For 2015: Forest and Paper Products Sector, Nov. 17, 2014 Business And Financial Risk Matrix Financial Risk Profile Business Risk Profile Minimal Modest Intermediate Significant Aggressive Highly leveraged Excellent aaa/aa+ aa a+/a a- bbb bbb-/bb+ aa/aa- a+/a a-/bbb+ bbb bb+ bb a/a- bbb+ bbb/bbb- bbb-/bb+ bb b+ bb- b Strong Satisfactory Fair bbb/bbb- bbb- bb+ bb Weak bb+ bb+ bb bb- b+ b/b- Vulnerable bb- bb- bb-/b+ b+ b b- Ratings Detail (As Of March 27, 2015) Stora Enso Oyj Corporate Credit Rating Nordic Regional Scale Senior Unsecured BB/Stable/B --/--/K-4 BB Corporate Credit Ratings History 11-Sep-2013 BB/Stable/B 25-Oct-2012 BB/Negative/B 22-Nov-2011 BB/Stable/B 15-Dec-2010 BB/Positive/B 11-Nov-2008 Nordic Regional Scale 11-Nov-2008 --/--/K-4 --/--/K-3 *Unless otherwise noted, all ratings in this report are global scale ratings. Standard & Poor's credit ratings on the global scale are comparable across countries. Standard & Poor's credit ratings on a national scale are relative to obligors or obligations within that specific country. Issue and debt ratings could include debt guaranteed by another entity, and rated debt that an entity guarantees. Additional Contact: Industrial Ratings Europe; Corporate_Admin_London@standardandpoors.com WWW.STANDARDANDPOORS.COM/RATINGSDIRECT MARCH 27, 2015 12 1391222 | 301444691 Copyright © 2015 Standard & Poor's Financial Services LLC, a part of McGraw Hill Financial. All rights reserved. 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