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Brazilian Companies Are Struggling Under The Burden Of COVID-19

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Airlines--negative outlook. While Latam Airlines Group S.A. has filed for Chapter 11 on May 26, 2020, the risk of distress debt negotiations for Azul S.A. and Gol Linhas Aereas Inteligentes S.A. remains amid structural changes in the industry for the next several years.

Demand for air travel dropped more than 90% in Brazil since late March and is likely to remain very weak at least for the first half of the year.  The path to recovery is highly uncertain, not only because of unclear duration of non-essential travel restrictions, but also because of travelers' fears of contagion. Also, the size of the corporate travelers' market may shrink permanently, because companies are increasingly adopting remote working while online meetings are more frequent.

The three Brazilian airlines are cutting costs and capex but they will continue burning cash in 2020.  Measures, including top management salary reductions, unpaid leaves, and adherence to government support package for workers' wages, slashed monthly cash outflows at least between April and June. But these airlines have high short-term debt maturities and working capital needs as travel starts to recover and cash outflows to refund unused tickets will squeeze liquidity. Airlines are also renegotiating aircraft deliveries, lessors' payments, and bilateral debt payments, while benefiting from the unprecedentedly low fuel prices. However, the Brazilian real's sharp depreciation and airlines' very low EBITDA will cause leverage to peak beyond 8x for 2020. We expect domestic flight volumes to recover more quickly, so airlines--such as Latam more exposed to international routes--could suffer more than peers.

The Brazilian Development Bank (BNDES) has offered fresh funds but costs and requirements might delay negotiations.  Latam--given that its Brazilian unit didn't file for bankruptcy--Gol, and Azul are discussing with BNDES a capitalization package, which also includes loans from private banks and capital market debt. Also, airlines are still objecting to BNDES' requirement to take equity ownership in the companies in return for financing.

Building materials--negative outlook. Sharp contraction in demand amid still low prices to pressure companies' cash flows.

We expect sales volumes to decline about 15% and EBITDA 30% in 2020 .  Given that the Brazilian cement industry lags other industries during downturns, we believe the pandemic-induced drop in demand for building materials will likely intensify during the second half of 2020. As consumer confidence falls, given expected lower real income and increase in unemployment, demand for construction will dwindle.

Volumes in Brazil dropped 20% in March year-over-year, but we expect a steeper fall as homebuilders suspend new launches, but finish projects currently under construction.  Geographically diversified cement producers, such as Votorantim Cimentos S.A., should be in a better position because they would benefit from operations in countries where the pandemic is receding while generating cash flows in stronger currencies. Smaller and less capitalized players could suffer the most, and we don't exclude consolidation in the market next year. Cement companies that were planning or already investing in modernization of Brazilian assets will likely postpone until 2021, reducing investments to maintenance levels. We don't expect additional significant contraction in prices and margins, because of the sector's already high idle capacity at about 45%.

Car rental--negative outlook. More stable fleet management cash flows and significant capex reductions mitigate the risk of low utilization rates for a longer period.

Brazilian car rentals are less exposed to airline passenger traffic than peers in other countries.  Air travelers only represent 10%-20% of each of the sector company's revenue base. The higher proportion of contractual clients, along with that of fleet management, shores up revenue stability. Still, we view risks for the renewal of such contracts and for higher delinquencies, which in turn depend on the severity of the economic contraction.

Utilization rates dropped to 55%-60% in April and first weeks of May due to movement restrictions from historical levels of 75%-80%.  We expect a gradual recovery, mainly in the fourth quarter of this year, leading to annual average utilization rates of 65%-70% and average tariffs 10%-20% lower than the 2019 level. Under such a scenario, we forecast EBITDA declines of 10%-20% in 2020 and a recovery in 2021, which recently led us to affirm the ratings on the sector's companies. If utilization rates remain at 55%-60% under current tariffs for the rest of 2020, the drop in EBITDA would deepen to 20%-30%, which could lead to downgrades.

Companies have adequate liquidity to operate through this year's turbulence.  Along with a smooth amortization profile for the year, companies have accessed credit markets in the initial stages of the pandemic, increasing cash positions. Meanwhile, used-car sales had slowed but began to bounce back in April and the first few weeks of May, with discounts among some players. We expect companies to use cash inflows from vehicle sales, combined with significant reductions in investments, to preserve their liquidity.

Consumer products--negative outlook. Stable demand offsets fragile discretionary consumption.

We expect demand for discretionary consumer products to drop 15%-20% this year.  Categories such as beverages and cosmetics will likely drop 50%, reaching a bottom in the second quarter of 2020. Companies are focusing on online platforms and adjusting their product mixes and channels. One example is the significant growth of online sales for Natura Cosmeticos S.A., with a soaring demand for hygiene products such as washing soap, antibacterial soap, and shampoo, while Avon's sales of hair dyes and cosmetics plummeted. We recently revised downward the stand-alone credit profiles (SACPs) of Avon and Natura Cosméticos, but cash injection of at least R$1 billion at the holding company helped stabilize the ratings on the group for now.

The high percentage of out-of-home alcoholic beverage consumption will squeeze the on-premise sales. Companies such as Ambev S.A. are gradually increasing volumes to the retailers, but margins will take a hit because of the lower dilution of fixed costs and fiercer price competition on the shelves, mainly as supply production remains intact. The biggest uncertainty is over return to normality, because more than 50% of alcohol volumes go to bars and restaurants.

The exception are food producers, such as Camil Alimentos S.A., whose revenue jumped as panic shopping for staple items peaked in late March and early April, and could be stable for the rest of the year. Ratings on Camil remain capped at the sovereign level, but struggles to access long-term funding could prompt us to revise its SACP downwards.

Electric utilities--stable outlook. Rated distributors have sufficient flexibility to absorb lower demand and higher delinquency rates until additional liquidity becomes available.

Brazilian utilities are in general more resilient to the effects of COVID-19 than most other sectors given the essential service they provide, and their regulated or long-term contracted nature. We expect utilities to withstand mostly due to their relatively comfortable liquidity positions and flexibility to accommodate investments and dividends if needed. Despite the projected lower operating cash flows in the short to medium term caused by the government measures to support cash-strapped consumers and by the lower demand (energy consumption was 13% lower in April) stemming from the economic downturn, we currently expect our ratings on Brazilian electric utilities to remain mostly steady amid the pandemic.

Overall, we expect electricity generators and transmission entities to be less exposed to the downturn than distributors. However, the regulator and government are currently drafting an extraordinary liquidity package to support the distributors, which in our view, are more exposed to working capital needs in this period. These companies collect revenues for the entire sector, while balancing the mismatch of lower demand and related energy surpluses, as well as increased delinquency.

Forest products--stable outlook. Resilient demand for tissue paper and packaging, and the weaker real should compensate for low prices and sales volumes.

Pulp prices will likely drop about 15% this year from already low levels amid global recession.  Demand for tissue and packaging should remain steady, while that for printing and writing paper will likely plunge, accelerating an already secular trend. The companies we rate in this sector are increasing the sales of tissue paper. We expect Asia to continue driving demand for the industry's products.

The real's depreciation should offset low prices and volumes this year.  This is because the Brazilian pulp companies' sales prices are in dollars and a large portion of paper products is exported, while costs are mainly in the reals. The companies could also tap available credit facilities and boost liquidity through asset sales, such as forests and lands.

The negative outlook on Suzano S.A. since the end of 2019 reflects its higher-than-expected leverage for the rating level. The real's falling value might even help the company reduce leverage and reach its financial policy targets in 2021. We have a stable outlook on Klabin S.A. Demand for its paper packaging has increased following the imposition of movement restrictions and the company is currently in the midst of an investment phase that's likely to increase leverage in 2020.

Homebuilders--negative outlook. Rising unemployment, and lower wage earnings and consumer confidence will take a substantial toll on housing demand, ultimately denting the industry's cash flows.

Demand to shrink.  Housing for low-income families, subsidized by the government program 'Minha Casa, Minha Vida', has shown more resilience in the past economic downturns than that for mid – to high-income families. We expect the same trend this time around. Developers will finish the ongoing projects, but launches are frozen for an indefinite period due to uncertainties over demand, resulting in lower revenue and cash flows this year. Nonetheless, we believe that the companies we currently rate have a sufficient liquidity cushion to go through the crisis given their cash positions and access to construction credit lines.

The companies' credit quality will depend on the duration of the pandemic-induced crisis and how quickly homebuyers' confidence bounces back. Apart from liquidity, we will focus on the developers' free operating cash flows and the magnitude of the impact on equity over the next few quarters, given that debt to capital is the most relevant metric for the sector.

We still believe that long-term prospects for the industry are strong.  This is due to high pent-up demand for housing and historically low interest rates, as highlighted in the article, "Brazil's Developers Look To Build On Favorable Housing Conditions," published on Feb. 4, 2020. Therefore, companies that continue to operate through currently difficult conditions may benefit from a future rebound in the sector.

Metals and mining—negative outlook. Companies have cut production of steel while leverage spiked. Prices for iron ore remain supportive.

Iron ore prices have been favorable since the start of the year, and are likely to remain so as China's industrial production gets back on track and suppliers cut output.  The recent spike in prices reflects the lower global output--mainly at Vale--as rainy weather slowed extraction. We still expect Vale's production to remain sizable, at around 330,000 tons of iron ore in 2020. Current prices at above $100 per ton will benefit EBITDA and cash flows for of Vale and integrated steel companies, mainly Companhia Siderurgica Nacional given that iron ore contributed 80% of EBITDA in 2019, and to a lesser extent, Gerdau S.A. and Usinas Siderurgicas de Minas Gerais S.A.. However, we have a negative outlook on Vale because of substantial environmental, social, and governance (ESG) risk factors, along with a CreditWatch negative listing on CSN because of liquidity pressures.

We expect steel volumes in Brazil to decline 15%-20% in 2020.  The likely contraction in volumes drives our negative outlooks on steel companies. The drop in volumes is also occurring in other countries where Gerdau has operations, such as the U.S., Chile, Mexico, etc. This is because of weak demand, especially from automotive and other industrial segments, as well as construction activity that may suffer more starting in the second half of 2020. As a result, Gerdau and Usiminas have suspended operations since the outbreak of coronavirus in the countries they operate, including blast furnace outages. CSN has just announced shutdowns starting in June. While debt is manageable and liquidity is robust for Gerdau and Usiminas, their credit metrics will weaken due to the dollar's depreciation and huge EBITDA decline. On the other hand, we see higher liquidity pressures for CSN amid refinancing difficulties in a more uncertain demand scenario.

We expect all steel companies to reduce capex and any shareholder remuneration, but a prolonged period of sluggish demand can trigger additional negative rating actions.

Oil and gas, and chemicals--negative outlook. Collapse in oil prices and demand are biting into companies' cash flows.

We expect Brent crude oil prices at $30/bbl for the remainder of 2020 and $50/bbl in 2021.  The oil and gas industry has been hit hard due to the plunge in demand resulting from the lockdowns and stifled air travel, along with high levels of production and inventories across the globe. Despite the OPEC+ agreement on supply cuts, a substantial imbalance in the market exists, which has been keeping oil prices at very low levels.

Petroleo Brasileiro S.A. - Petrobras' revenue and EBITDA to drop 30%-40% this year.  To partly compensate for the contraction in demand, the company has cut its capex plan and took several measures to reduce costs and preserve liquidity. Although we have an overall negative outlook for the industry, our outlook on Petrobras is stable, because company's 'bb' SACP is higher than the final rating, which is capped at the level of the sovereign rating. We expect Petrobras' leverage to peak this year at around 6x, but decline close to 4x in 2021, given the expectations for higher sales and oil prices. Still, if we were to expect a delay in the rebound of EBITDA and cash generation for next year, we could revise downwards our SACP on Petrobras to 'bb-' over the coming months.

We also expect the Brazilian chemicals industry to generate weaker cash flows given that most of end-customers are likely to grapple with significant volumes contraction. That will be the case especially for the auto manufacturing, housing and construction, and industrials sectors. The mitigating factors for the chemicals industry are the sales of chemicals for medical and packaging end-use, volumes for which might increase. We will likely see overall low prices this year because they're generally tied to oil prices. Still, Braskem S.A.'s cost structure, for instance, benefits from the lower petrochemical prices. Braskem's products spreads should benefit from competitiveness of its naphtha-based crackers over its global peers because most of them produce gas-based crackers. In addition, given that a significant share of Braskem's revenues is coming from exports, revenues from the latter should rise on weaker real.

Protein producers--stable outlook. Retail and export sales are shoring up margins and cash flows.

In our view, fundamentals remain favorable but profit volatility persists.  This is because the industry is facing many sources of disruption, from plant shutdowns in the U.S. and Brazil to a huge decline in demand at bars and restaurants, which is the main channel for premium meat cuts not only in Brazil but also in Europe. These factors led us to revise the outlook on Minerva S.A. and BRF S.A. to stable from positive. Currently all five Latin American protein companies we rate have a stable outlook.

We expect companies to maintain fairly stable leverage and raise EBITDA.  This will stem from higher cash flows from exports amid the falling real and from higher retail sales and growing demand from Asia offsetting the lower demand from the foodservice sector. We expect more conservative financial policies especially regarding M&A and dividends because of uncertainties over the duration of plant closures and demand patterns.

Railroad--stable outlook. Considerable exposure to more resilient agricultural products amid lower fuel costs.

We expect cash flows among railroad operations to remain relatively stable as volumes mainly consist of export commodities.  In addition, the weaker Brazilian real, combined with a steep reduction in fuel costs could further prop up the companies' margins. We haven't observed any disruptions in port operations or logistics issues. Still, operations could suffer in case of stricter lockdowns or further movements restrictions if COVID-19 is not contained. Despite economic and political uncertainties, the likelihood of early concession renewals is rising, as was the case for Rumo S.A.'s Paulista Network concession. We expect a very limited impact on cash outflows in the short term, given that fees for renewing concession tend to be distributed over its term. During the initial stages of the pandemic, we observed companies drawing down committed credit lines in order to increase cash position. Such initiatives, combined with the lower investments for the year, should allow railroad operators comfortable liquidity positions to weather the current crisis.

Retail (grocery)--stable outlook. Demand for essential products such as food should remain resilient throughout the crisis.

As signs of COVID-19 cases started cropping up in Brazil, grocery stores were crowded with consumers stocking up on food and other products to face quarantine, generating historically high same-store sales for that period, which in some cases were 2x-3x higher than in regular months. Grocery stores, together with pharmacies are considered as essential service providers; therefore, they remain opened, while other retailers were ordered to close. We expect margins to remain stable as higher sales should be offset by incremental costs.

Consequently, we expect the ratings on Companhia Brasileira de Distribuicao (brAA-/Negative/--) and Atacadao S.A. (brAAA/Stable/--) to remain unaffected. Also, we don't expect refinancing risks for both entities, while they have also raised new funds to support liquidity if needed. We currently don't expect changes to dividends policy, but capex could be postponed in some cases to protect cash position.

Retail (non-grocery)--negative outlook. Discretionary retailers to focus on cost reduction and online sales, but damage to bottom-line results will be substantial.

We believe restaurants and discretionary product retailers will continue facing huge challenges in the next 12-18 months.

Most companies already closed a significant number of stores, which coupled with layoffs and labor contract revisions as permitted by local laws, are the main avenues for reducing fixed costs. However, these measures aren't sufficient to compensate for a drastic decrease in sales, denting cash flows--and consequently--credit metrics and liquidity.

Despite a solid liquidity position, and historically strong operations, Lojas Renner S.A. (brAAA/Negative/--) is grappling with dramatically lower sales and cash flows. After the 30-40 day long lockdown, it has started to reopen stores, but most of stores are only operating as hubs for delivery of products via drive-through in shopping malls. We expect a wide shortfall in same-store sales in the second quarter and recovery to start in the third quarter.

Magazine Luiza S.A. (brAAA/Stable/--) reported 50% of 2019 revenue coming from e-commerce, and we believe this channel will continue delivering a significant share of sales from in 2020. However, such venues may not be sufficient to compensate for a dramatic decrease in physical store sales, given that the close interaction with customers is key in offering credit to boost overall sales. We believe delinquency rates will increase and could reach similar levels as in the last domestic financial crisis. Due to the capital increase in 2019, we don't expect a negative rating action on Magazine Luiza because it could use excess funds to protect liquidity.

We downgraded the Brazilian restaurant retailer International Meal Company Alimentacao S.A. (brBBB-/Watch Neg/--) due to much weaker operations after several store closures and the potential for a delayed reopening of operations. Restaurants remain closed with some operating for takeouts or delivery, which isn't sufficient to cover the material loss of physical stores' revenues.

Sugarcane--negative outlook. Vulnerability to dollar-denominated debt and inability to switch to sugar production from ethanol could trigger downgrades.

The restrictions on movement have reduced gasoline and ethanol consumption by around 30% in April.  And it's likely to remain anemic in the second quarter. At the same time, historically low global oil prices depressed domestic prices, given that Petrobras is passing through most of this decline to maintain the price parity. In this sense, sugarcane processors with operating and financial flexibility are increasing sugar output in detriment of the biofuel and carrying over ethanol inventories, to sell in the end of the year when demand should recover somewhat and prices tend to increase during the inter harvest.

The offsetting factors are sugar prices that are set in the Brazilian real and some companies' ability to increase sugar output.  These factors will help diminish supply of ethanol. We believe that ramping up sugar production among Brazilian companies could reduce ethanol output by about 4 billion liters, which will support prices at the end of the harvest season, if demand recovers as expected. Liquidity and capital structure will drive rating actions in the sector, with the companies with sizable dollar-denominated debt and refinancing risks as more vulnerable. We still forecast the sector's companies to crush the entire volume of the planted cane during this harvest, but a much weaker demand could prompt them to review strategies and lower cash flows, consecutively, increase leverage.

Telecom--stable outlook. Overall resilience thanks to high demand for broadband and post-paid services, partly offset by the accelerating downward trends in fixed-line, pay-TV and pre-paid services.

We believe COVID-19 could lower subscriber additions, given the closures of point-of-sales, while accelerating the cord-cutting phenomenon in the fixed line and pay-TV businesses as people reduce expenses and delay prepaid recharges. Therefore, companies with greater exposure to fixed line, especially copper network, prepaid mobile, and pay-TV will suffer more. In addition, we expect weaker cash collections to pressure credit metrics and liquidity. Brazil's large informal economy, coupled with disruptive restrictions on movement, may slash customers' payments in cash, particularly during the peak weeks of the pandemic. On the other hand, we expect increase in data traffic and voice usage to boost revenue for fixed broadband and postpaid services.

In the B2B sector, we expect revenues to rely on bandwidth needs and networking solutions, rather than employee count, which mitigates the risk that the rising unemployment rate posed to the enterprise segment's revenue trajectory, as seen a decade ago. Corporate customers affected by the crisis might delay payments, although we don't expect massive write-offs because access to telecom should remain a priority service for the enterprise segment.

We believe the telecom sector is more resilient than most industries, and expect most of the rated companies to focus on expense control, posting healthy EBITDA margins and free operating cash flows during the next 12 months. In addition, we believe Telefonica Brasil S.A. (brAAA/Stable/--) and Algar Telecom S/A (brAAA/Stable/--) have strong balance sheets and adequate liquidity to operate through the crisis. On the other hand, we took a negative rating action on Oi S.A. (brBBB-/Negative/--) on March 11, 2020, due to its deteriorating credit metrics mainly because of the falling value of the real (approximately 50% of the company's debt is in dollars), potential impacts on pre-paid and fixed line segments, as well as less-than-adequate liquidity.

Transportation infrastructure--stable outlook. Although exposed to anemic economic activity, infrastructure assets that we rate have enough financial flexibility.

The main difference between the current and previous economic crises is that containing the pandemic relies on imposing movement restrictions. This imperils the operations of various infrastructure assets, particularly in the transportation segment, including airports, toll roads, subways--and to a lesser extent--ports. Commuter traffic in Brazil plunged close to 50% and heavy traffic about 20% during April, but the severity depends on the geographic location of the asset. Still, unlike traffic at airports, we expect that on toll roads to rebound by the end of 2020, as commuters resume normal daily activities.

Traffic Assumptions Compared With 2019 Levels
2020 2021
Vehicles Heavy Light Total Heavy Light Total

AB Concessoes S.A.

(10)-(15) (15)-(20) (10)-(15) (2,5)-(5,0) 0-5 0-(2,5)

Arteris S.A.

(10)-(15) (20)-(25) (10)-(15) 2.5-5.0 2.5-5.0 2.5-5.0


(8)-(13) (15)-(20) (10)-(15) 5-10 5-10 5-10

Ecorodovias Concessoes e Servicos S.A.

(5)-(10) (15)-(20) (10)-(15) 5-10 5-10 5-10

Nevertheless, the toll roads that we rate and that comprise the bulk of our rated portfolio of transportation assets in the country, are owned by large groups that operate portfolios of assets, allowing greater financial flexibility and comfortable liquidity position. The negative outlook on the two container terminals that we rate in Brazil, Santos Brasil Participacoes S.A. (brAAA/Negative) and Terminal de Conteineres de Paranagua S.A (brAAA/Negative/brA-1+), reflect their exposure to foreign trade, especially imports from China and exports to Europe and North America. We estimate a drop of more than 15% of containers handled in Brazil for 2020, with continued downside in 2021 following a global trade recession.

Still, we expect credit metrics of toll roads and ports to gradually improve to historical levels, after reaching a trough in 2020. We also cap most of our ratings on infrastructure assets at the sovereign rating level, so there's a cushion to absorb lower cash flows without immediately triggering rating actions.

Related Research

  • COVID-19 To Dim, But Not Darken, Brazilian Electric Utilities' Operations, May 29, 2020
  • Protein Processors Scramble To Adjust To Disruption From Pandemic, April 29, 2020
  • Outlook On 29 Brazilian Corporations Revised To Stable From Positive On Same Action On Sovereign, April 7, 2020
  • Brazil Outlook Revised To Stable From Positive On Uncertainty Related To COVID-19; 'BB-/B' Ratings Affirmed, April 6, 2020

This report does not constitute a rating action.

Primary Credit Analysts:Flavia M Bedran, Sao Paulo + 55 11 3039 9758;
Diego H Ocampo, Buenos Aires (54) 114-891-2116;
Luisa Vilhena, Sao Paulo (55) 11-3039-9727;
Wendell Sacramoni, CFA, Sao Paulo (55) 11-3039-4855;
Marcelo Schwarz, CFA, Sao Paulo (55) 11-3039-9782;
Secondary Contacts:Luciano D Gremone, Buenos Aires (54) 114-891-2143;
Julyana Yokota, Sao Paulo + 55 11 3039 9731;

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