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In This List
COMMENTS

COVID-19 And Falling Rates Cloud The Outlook For U.S. Financial Institutions

COMMENTS

COVID-19 Impact: Key Takeaways From Our Articles

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ESMA’s Stress Test Gives Clearinghouses Food For Thought

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COVID-19 Battered Global Consumer Discretionary Sectors But Lifted Staples; Recovery Varies By Subsector

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Banking Industry Country Risk Assessment: Uruguay


COVID-19 And Falling Rates Cloud The Outlook For U.S. Financial Institutions

In just recent days, the rise of cases of COVID-19 has led to a cut in the Federal Reserve's target rate and sharply falling asset prices, perhaps ending a period of benign conditions that most rated U.S. banks and nonbank financial institutions (NBFIs) enjoyed in recent years. COVID-19 could negatively affect revenue, asset quality, and funding conditions. Lower rates--while meant to offset the epidemic--will almost certainly pressure banks' net interest margins (NIM) and profitability.

The impact of COVID-19 on the economy and financial institutions (FIs) ultimately will depend in large part on its duration and severity, and how successful governments and central banks are in responding to it. S&P Global economists currently expect the epidemic to slow U.S. GDP growth to a 1% average sequential (seasonally adjusted annualized) rate in the first two quarters of 2020 before a second-half rebound. That would take 0.3 percentage points off our previously published 1.9% U.S. GDP growth forecast for this year. That assumes the epidemic subsides in the second quarter. We believe that would be a manageable scenario for most FIs without a drastic deviation from the outlooks we laid out for banks and NBFIs at the beginning of this year (see "U.S. Bank Outlook For 2020 Anticipates Some Potholes Amid Search For Growth," Jan. 13, 2020, and "2020 Nonbank Financial Institution Sector Outlooks Published," Jan. 17, 2020). However, even under a benign scenario, banks' net interest income could fall given lower rates.

If COVID-19 trims more than 0.3 percentage points from U.S. GDP, its threat to FI performance will grow. We believe that parts of commercial and industrial, commercial real estate, auto, and credit card lending are areas that could see increases in problem assets in a downturn. Fees generated from areas like investment banking, asset and wealth management, and payments seem most likely to slow or drop if COVID-19 weighs on market and business sentiment. The availability of funding for NBFIs could also worsen, and there could be operational challenges associated with relocating employees or having them work remotely to avoid the virus. Mortgage origination revenue could be one bright area as low rates could drive higher refinancing activity.

Low rates will also constrain the net interest income of banks and certain NBFIs. The quarterly NIM of U.S. banks in aggregate already fell about 20 bps in 2019, following the end of the Fed's rate tightening cycle and the subsequent 75-bps reduction in its target for the fed funds rate in the second half of the year. With the additional 50-bps cut in early March 2020--taking the Fed's target to 1.00%-1.25%--U.S. bank NIMs are likely to fall closer to the level they were when the Fed started raising rates from 0%-0.25% in December 2015. That leaves open the possibility that banks could face a double whammy of falling NIMs and rising credit losses as a result of lower rates and a weaker economy. For NBFI, the double whammy would be rising credit losses and weaker access to funding.

Such a scenario could lead to negative rating actions depending on its severity. Positively, U.S. banks are largely starting from a position of strength with good levels of capital and liquidity, low asset quality problems, and generally strong earnings, meaning it would likely take a substantial downturn to trigger widespread downgrades. Given the diversity of the NBFI sector, it is difficult to generalize. Although many have bolstered their funding and liquidity in recent years, speculative-grade NBFIs (those rated 'BB+' or below) tend to have riskier profiles, probably making them more susceptible to worsening of conditions. Those that make higher-risk loans, are highly leveraged, or are more dependent on shorter-term funding would be most exposed.

The Potential Impact Of COVID-19 On The Economy, Asset Quality, And Loan Loss Reserves

S&P Global economists expect COVID-19 to take 0.5 percentage points and 0.3 percentage points off our respective GDP growth baseline forecasts (from December 2019) for the global (3.3%) and U.S. economies (1.9%) partly based on the assumption that the epidemic will subside during the second quarter (see "COVID-19's Wider Reach Deepens Shadow Over Global Economies And Credit," March 3, 2020).

If COVID-19 sparks a greater slowdown than that, currently-benign asset quality will undoubtedly deteriorate. It is too early for us to make precise predictions. However, particularly under an adverse scenario, we would expect stress on loans to borrowers in areas dependent on consumer discretionary spending (retail, leisure, transport/travel, and infrastructure) or supply chains (autos, technology, and commodities), and in energy. Defaults in leveraged lending--which has grown substantially in size and risk over several years--could also rise sharply, especially in the sectors listed above.

While most banks have limited exposure to leveraged loans, they are not immune. For instance, the large banks originate and syndicate leveraged loans, hold some on balance sheet, and retain some undrawn commitments to leveraged borrowers and others involved in leveraged finance (see "Six Key Risks In Leveraged Lending For Financial Institutions," Nov. 26, 2018). Certain NBFI that focus almost exclusively on leveraged lending, such as business development companies, would probably see a greater proportional impact.

Also, pockets of commercial real estate in certain geographies and asset types, such as retail and office space, could also worsen. Loans to consumers would also deteriorate with a rise in unemployment. For instance, the asset quality of auto loans held by both banks and NBFIs probably would decline following a long period of loan growth. The same is true in student lending, although most of that risk is held by the federal government. Credit card loans, which have grown more in the last few years, also tend to be highly sensitive to economic conditions. A handful of banks dominate credit card lending.

Banks and NBFIs also may be forced to increase their expectations for lifetime losses on their loans--which they just implemented as of Jan. 1, 2020, as part of the new current expected credit losses (CECL) accounting standards. If that happens, they will have to raise their provisions and reserves for loan losses, perhaps significantly. That too would weigh on earnings and capital.

The Likely Impact Of Lower Rates On The Net Interest Margins Of U.S. Banks

U.S. banks benefited substantially when the Fed raised rates between 2015 and 2018 as the yield on their assets rose faster than the cost of their liabilities. Alongside the cut in U.S. corporate tax rates that went into effect into 2018, that trend drove significantly higher net interest income and record earnings.

Chart 1

image

Since the Fed has been cutting rates, banks have been experiencing the opposite effect, with NIMs in decline. According to the Federal Deposit Insurance Corp. (FDIC), U.S. banks in aggregate reported a NIM of 3.28% in the fourth quarter of 2019, down from 3.48% a year earlier. Because of that drop, net interest income only rose 1% for the industry in 2019 despite continued asset growth.

Chart 2

image

Before the rise of COVID-19 and the recent Fed rate cut, we had expected only moderate further NIM contractions in 2020. However, we now believe NIMs are likely to fall this year closer to the 3.02%-3.12% levels banks exhibited in 2015, just before the Fed began raising rates.

In addition, certain factors could push NIMs even lower over time. For instance, the yield curve is currently flatter than in 2015. The spread between the 10-year and two-year Treasury, now close to zero, was greater than 1% in 2015. As a result, when banks reinvest the proceeds from maturing loans and securities, they generally do so at lower rates. If the yield curve remains flat or negative, NIMs should fall further over time.

Loan growth could at least partially offset the impact of falling NIMs on net interest income. However, if COVID-19 slows loan growth or causes contraction, net interest income, and therefore earnings, could fall meaningfully. Furthermore, if the Fed cuts rates again, it will likely pressure net interest income even more.

We estimate that the Fed's 50-bps cut in rates could lead to a roughly 2% decline in net interest income, assuming 3% earning asset growth, a 50% earning asset beta, and a 25% liability beta. All else equal, that could lead to a 4% decline in earnings. (The betas measure how far asset yields and liability costs, respectively, would fall in proportion to the change in the Fed funds rate. For instance, a 50% earning asset beta implies the average yield banks earn on their earning assets would fall 25 bps for every 50-bps cut in the fed funds rate.)

If the Fed cuts rates further, especially if its target range goes back to zero, banks will likely see substantial NIM pressure beyond 2020 and likely meaningful declines in earnings, all else equal. For instance, we estimate that bank earnings would fall 23% in the same initial scenario described above if the fed funds rate dropped a further 100 bps (or 150 bps from the December end-of-quarter level) (see tables 1-2). A reduction in fee income, possibly offset somewhat by expense initiatives, could further affect net income.

Table 1

Earnings Impact of Reduced Interest Rates: All FDIC Commercial Banks
Scenario: 50% earning asset beta; 25% interest-bearing liabilities; 3% asset growth
--Result with change in rates of:-- --% Impact with change in rates of:--
(Bil. $) 4Q19 Actual 50 bps 150 bps 50 bps 150 bps
Yield on earning assets (%) 4.17 3.92 3.42 (0.25) (0.75)
Cost of interest-bearing liabilities (%) 1.19 1.07 0.82 (0.13) (0.38)
Net interest margin (%) 3.28 3.12 2.81 (0.16) (0.47)
Average earning assets 16,658 17,158 17,158 3.00 3.00
Average interest-bearing liabilities 12,448 12,821 12,821 3.00 3.00
Net interest income 136.8 134.0 120.6 (2.04) (11.86)
Pretax income 69.3 66.5 53.1 (4.03) (23.41)
Net income 55.2 53.0 42.3 (4.03) (23.41)
Tax rate (%) 20.3 20.3 20.3

Table 2

Sensitivity Table: Impact Of 50-Basis-Point Rate Cut On Net Income*
Assuming 50% earning asset beta
--Average earning asset growth (%)--
Liability beta (%) 0% 3% 5% 7%
15 (11.9) (6.3) (2.6) 1.1
25 (9.7) (4.0) (0.3) 3.5
35 (7.4) (1.7) 2.1 5.9
45 (5.2) 0.6 4.4 8.3
*This is the sensitivity to the 50-bps rate cut made in early March 2020 and compares to fourth-quarter 2019.

Table 3

Sensitivity Table: Impact Of 150-Basis-Point Rate Cut On Net Income
Assuming 50% earning asset beta
--Average earning asset growth (%)--
Liability beta (%) 0% 3% 5% 7%
15 (35.2) (30.4) (27.1) (23.9)
25 (28.5) (23.4) (20.0) (16.7)
35 (21.7) (16.5) (13.0) (9.4)
45 (15.0) (9.5) (5.9) (2.2)
*This is the sensitivity to a 150 bps rate cut, including the 50 bps cut made in early March 2020, and compares to fourth quarter 2019.

In February before the 50-bps Fed rate cut, JPMorgan Chase & Co., the country's largest bank, forecasted a slight decline in its 2020 net interest income based on an expectation of two rate cuts of 25 bps this year. With the more accelerated cut, presumably that forecast could drop further.

Performance of individual banks could vary substantially. We believe those banks that accrued the greatest benefits from rising rates are likely to see the greatest pain from falling rates. More specifically, we expect banks with the following characteristics, in some combination, to face the most pressure from lower rates:

  • A high reliance on net interest income as percent of revenue (generally higher than the 70% median for rated U.S. banks)
  • A high mix of interest-sensitive assets, including floating-rate loans and securities and assets scheduled to mature within a year
  • A high mix of deposits already priced close to zero or that showed little repricing up during the rate-tightening cycle (often core retail deposits and non-interest-bearing commercial deposits)
  • A high level of fixed-rate securities with prepayment risk (such as mortgage-backed securities)

In contrast, the minority of banks that experienced NIM declines when rates were rising may perform best. Some of those banks have low levels of interest-sensitive assets and had to reprice their deposits up meaningfully when rates were rising. That could reverse to some extent.

Table 4

Indicators Of Potential Sensitivity To Interest Rates
Sorted by greatest increase in NIM from 2015 to 2018
(%) NIM Change in NIM 4Q15 to 4Q18 (bps) Change in NIM 4Q18 to 4Q19 (bps) Change in NIM 4Q15 to 4Q19 (bps) Net interest income / revenue Interest-sensitive assets/ assets Cost of interest-bearing deposits Non-interest-bearing deposits / deposits Mortgage-backed securities / assets
MEDIAN 3.21 34 (18) 16 69.7 43.3 1.00 25.1 10.1

Comerica Inc.

3.20 113 (52) 61 67.4 70.1 0.93 48.0 13.1

SVB Financial Group

3.25 112 (43) 69 64.1 45.8 0.92 66.3 20.3

BBVA USA Bancshares Inc.

2.93 82 (40) 42 69.6 49.7 1.42 27.2 9.3

M&T Bank Corp.

3.65 82 (29) 53 65.8 52.6 0.77 34.2 7.2

BOK Financial Corp.

2.81 77 (50) 27 62.6 39.3 0.75 6.7 19.1

CIT Group Inc.

2.05 75 (31) 44 43.8 46.0 1.92 4.5 9.4

Texas Capital Bancshares Inc.

2.93 74 (82) (8) 94.6 90.7 1.63 35.7 0.0

Synovus Financial Corp.

3.60 73 (30) 43 80.0 49.9 1.17 24.6 12.2

OFG Bancorp

5.35 70 8 78 81.5 40.8 1.02 21.8 7.2

First BanCorp

4.74 69 (7) 62 85.5 29.5 1.21 25.3 13.7

Commerce Bancshares Inc.

3.31 67 (18) 49 58.1 42.2 0.38 33.6 15.1

First Horizon National Corp.

3.27 62 (11) 51 63.7 54.0 1.11 26.0 8.4

Webster Financial Corp.

3.25 61 (42) 19 76.9 43.2 0.67 19.5 16.2

Sallie Mae Bank

5.53 57 (69) (12) 99.0 61.3 2.41 0.0 0.7

Synchrony Bank

11.21 57 (183) (126) 90.5 50.9 2.34 0.4 0.9

Cullen/Frost Bankers Inc.

3.33 55 (8) 47 72.8 41.3 0.49 39.5 8.0

State Street Corp.

1.37 53 (12) 41 21.5 54.2 0.27 18.7 17.1

East West Bancorp Inc.

3.50 49 (31) 18 85.7 62.7 1.35 29.8 2.4

First Hawaiian Bank

3.16 49 (5) 44 75.6 32.3 0.67 35.9 16.8

Regions Financial Corp.

3.36 47 (14) 33 61.9 39.8 0.64 35.3 12.8

Ally Financial Inc.

2.47 46 2 48 58.2 22.7 2.12 0.1 14.3

First Commonwealth Financial Corp.

3.74 45 3 48 75.6 48.0 0.75 25.3 10.9

First Midwest Bancorp Inc.

3.72 45 (24) 21 76.3 46.4 0.63 28.7 10.2

Fifth Third Bancorp

3.32 44 0 44 55.2 45.2 0.89 28.5 8.3

Citizens Financial Group Inc.

3.06 43 (18) 25 70.2 43.2 1.11 23.8 12.5

UMB Financial Corp.

2.95 43 (22) 21 61.1 49.3 1.02 32.2 12.2

American Express Co.

5.16 42 33 75 20.1 58.7 1.95 3.9 0.0

Northern Trust Corp.

1.57 40 9 49 27.2 52.6 0.47 24.1 8.8

American Savings Bank F.S.B.

3.74 37 (21) 16 70.0 21.0 0.36 30.9 13.7

Discover Financial Services

9.12 36 14 50 85.8 68.8 2.18 1.2 0.6

JPMorgan Chase & Co.

2.25 34 (14) 20 50.0 46.4 0.67 26.6 5.3

KeyCorp

2.93 34 (18) 16 60.4 43.3 0.97 25.8 14.1

Cadence Bancorp

3.89 33 34 67 83.1 53.3 1.52 26.0 10.3

Huntington Bancshares Inc.

3.13 32 (28) 4 67.2 36.4 0.88 24.7 13.0

Bank of America Corp.

2.24 32 (14) 18 58.0 47.2 0.62 29.1 14.0

Zions Bancorporation

3.44 31 (20) 11 79.0 40.4 0.76 41.3 12.7

PNC Financial Services Group Inc.

2.77 30 (18) 12 54.1 41.8 0.88 25.2 12.9

TCF Financial Corp.

3.88 29 (82) (53) 72.0 36.8 1.16 23.2 10.9

People's United Financial Inc.

3.12 28 (3) 25 78.1 36.3 1.04 22.5 5.0

Bank of New York Mellon Corp.

1.08 26 (15) 11 17.0 60.7 0.74 22.2 14.6

Associated Banc-Corp

2.77 23 (20) 3 68.4 41.6 0.98 22.9 4.5

S&T Bancorp Inc.

3.22 20 (39) (19) 81.4 50.8 1.03 12.8 2.4

Hancock Whitney Corp.

3.39 19 5 24 73.5 28.3 1.12 36.9 10.0

Truist Financial Corp.

3.37 19 (9) 10 60.0 39.6 0.83 27.6 14.5

Capital One Financial Corp.

6.93 15 (2) 13 81.7 45.5 1.41 8.9 16.5

Western Alliance Bancorporation

4.42 15 (16) (1) 94.9 42.8 0.70 37.5 9.5

IBERIABANK Corp.

3.19 15 (60) (45) 79.9 35.0 1.50 25.1 9.2

U.S. Bancorp

2.90 13 (24) (11) 57.1 43.3 0.93 20.9 19.0

Wells Fargo & Co.

2.56 11 (41) (30) 58.0 39.4 0.85 26.1 13.2

BMO Financial Corp.

2.26 7 (11) (4) 65.9 42.6 1.38 22.1 6.9

First Republic Bank

2.67 4 (25) (21) 82.6 22.5 0.94 36.8 2.2

Goldman Sachs Group Inc.

0.46 1 2 3 10.7 50.2 1.89 0.2 0.1

Valley National Bancorp

2.95 0 (15) (15) 86.2 12.9 1.59 23.0 7.7

Morgan Stanley

0.85 (12) 18 6 16.5 46.4 0.95 1.1 3.7

Trustmark Corp.

3.48 (13) 0 (13) 69.5 35.2 0.86 25.7 15.1

Popular Inc.

3.86 (19) (39) (58) 74.8 39.1 0.88 18.9 10.5

Bank of the West

2.72 (22) (27) (49) 81.5 28.4 1.28 24.2 16.7

BancorpSouth Bank

3.75 (23) (3) (26) 69.8 36.6 0.96 27.8 0.6

Umpqua Holdings Corp.

3.60 (23) (64) (87) 73.4 44.5 1.14 30.8 6.6

Citigroup Inc.

2.54 (23) (7) (30) 66.0 54.5 1.25 17.2 4.1

Investors Bancorp, Inc.

2.60 (36) (7) (43) 90.2 11.9 1.59 14.5 11.8

MUFG Americas Holdings Corporation

1.98 (48) (22) (70) 53.3 45.3 1.26 32.9 7.6

Santander Holdings U.S.A. Inc.

4.65 (56) (46) (102) 65.0 44.1 1.12 22.7 7.4

New York Community Bancorp Inc.

2.03 (95) (8) (103) 93.3 17.2 1.66 7.7 3.7

Table 5

Company Projected Interest Sensitivity
(From year-end 2019 or mostly recently available)
Change in net interest income (%) Based on rate change of (bps) Pace of rate change
MEDIAN (2.4) (100)

Bank of America Corp.

(13.2) (100) Immediate

SVB Financial Group

(8.5) (100) Immediate

Texas Capital Bancshares Inc.

(8.3) (100) Immediate

Comerica Inc.

(6.0) (100) Gradual

CIT Group Inc.

(5.8) (100) Immediate

First Midwest Bancorp Inc.

(5.6) (100) Immediate

Trustmark Corp.

(5.2) (100) Immediate

BBVA USA Bancshares Inc.

(5.0) (100) Gradual

State Street Corp.

(4.9) (100) Immediate

Webster Financial Corp.

(4.7) (100) Gradual

Zions Bancorporation

(4.6) (100) Immediate

Northern Trust Corp.

(4.6) (100) Gradual

U.S. Bancorp

(3.9) (200) Gradual

S&T Bancorp Inc.

(3.8) (100) Immediate

Umpqua Holdings Corp.

(3.8) (100) Immediate

IBERIABANK Corp.

(3.7) (100) Immediate

JPMorgan Chase & Co.

(3.5) (100) Immediate

Hancock Whitney Corp.

(3.2) (100) Immediate

Santander Holdings U.S.A. Inc.

(3.1) (100) Immediate

BOK Financial Corp.

(2.9) (100) Immediate

Regions Financial Corp.

(2.8) (100) Immediate

Fifth Third Bancorp

(2.7) (100) Gradual

East West Bancorp Inc.

(2.6) (100) Gradual

First Commonwealth Financial Corp.

(2.4) (100) Gradual

MUFG Americas Holdings Corp.

(2.4) (100) Gradual

M&T Bank Corp.

(2.3) (100) Gradual

PNC Financial Services Group Inc.

(2.2) (100) Gradual

People's United Financial Inc.

(2.1) (100) Immediate

Cullen/Frost Bankers Inc.

(1.9) (100) Gradual

Citizens Financial Group Inc.

(1.9) (100) Gradual

OFG Bancorp

(1.8) (100) Gradual

Western Alliance Bancorporation

(1.7) (100) Gradual

Popular Inc.

(1.4) (100) Gradual

First BanCorp

(1.3) (200) Gradual

Bank of New York Mellon Corp.

(1.3) (100) Gradual

Truist Financial Corp.

(1.2) (50) Gradual

SunTrust Banks Inc.

(0.9) (50) Immediate

Synovus Financial Corp.

(0.8) (25) Gradual

First Republic Bank

(0.8) (100) Gradual

Capital One Financial Corp.

(0.5) (50) Immediate

Valley National Bancorp

(0.5) (100) Immediate

Commerce Bancshares Inc.

(0.4) (100) Gradual

Huntington Bancshares Inc.

(0.3) (100) Gradual

KeyCorp

1.0 (100) Gradual

Cadence Bancorp

1.7 (100) Immediate

UMB Financial Corp.

1.7 (100) Gradual

Investors Bancorp Inc.

5.8 (100) Immediate

Low Rates Will Also Hurt Retail Securities Firms

The profitability of retail securities firms, which often make a significant portion of earnings on the uninvested cash balances of their customers, will suffer from lower short-term rates. This is on top of the decline in asset-based fees they will face if equity markets don't rebound soon from their recent fall. For highly leveraged private-equity-owned independent brokers, this will likely strain debt service coverage and reduce cushions on debt to EBITDA-based covenants, for those that have them. The profitability impact is magnified for the discount brokers that recently went to zero commissions on most equity trades.

Funding Access Could Worsen For NBFIs

For most of the last decade, NBFIs have found relatively easy access to funding from capital markets and banks. However, during times of volatility that can dry up, and those reliant on short-term debt can be particularly affected. In the event that COVID-19 weakens the economy and the credit quality of NBFI borrowers, NBFIs themselves may have a harder time accessing funding.

In fact, we think the mostly likely default scenario for many rated NBFIs during a financial crisis would be a loss of access to funding from banks or other liquidity sources (see "For Nonbank Financial Institutions, Reliance On Bank Lending Could Raise Default Risk In A Downturn," Nov. 20, 2019). For instance, transitional commercial real estate lenders could face margin calls on the repurchase facilities they commonly use, and independent auto lenders may see a drop in asset-backed security issuance.

Many FIs Enter This Period From A Position of Strength

Partly because of the improvements put in place after the financial crisis, banks have far higher levels of capital and liquidity now than they did in 2007 and 2008. For instance, in aggregate, FDIC-insured commercial banks reported a Tier 1 ratio of greater than 13%, well above the 9.4% ratio in 2007. Banks also generally have good liquidity, low levels of nonperforming assets, and have been reporting double-digit returns on equity.

Chart 3

image

We believe that should enable most rated banks to weather significant stress in the markets, although an extended downturn would certainly present significant challenges.

There is much greater variation in the financial strength and ratings of NBFIs. Even though most have pushed out debt maturities in recent years, some may still struggle if COVID-19 causes an extended downturn.

Related Research

  • Coronavirus Impact: Key Takeaways From Our Articles, March 9, 2020
  • COVID-19's Wider Reach Deepens Shadow Over Global Economies And Credit, March 3, 2020
  • Coronavirus Update: A Bigger Hit To First-Half U.S. Growth, March 3, 2020
  • U.S. Bank Outlook For 2020 Anticipates Some Potholes Amid Search For Growth, Jan. 13, 2020
  • 2020 Nonbank Financial Institution Sector Outlooks Published, Jan. 17, 2020
  • For Nonbank Financial Institutions, Reliance On Bank Lending Could Raise Default Risk In A Downturn, Nov. 20, 2019

This report does not constitute a rating action.

Primary Credit Analyst:Brendan Browne, CFA, New York (1) 212-438-7399;
brendan.browne@spglobal.com
Secondary Contacts:Sebnem Caglayan, CFA, New York (1) 212-438-4054;
sebnem.caglayan@spglobal.com
Devi Aurora, New York (1) 212-438-3055;
devi.aurora@spglobal.com
Stuart Plesser, New York (1) 212-438-6870;
stuart.plesser@spglobal.com

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