- While Ukraine has not received a disbursement under its IMF program since March 2017, we anticipate that a new program announced by the IMF will be approved by the end of 2018.
- We expect the new arrangement will aid Ukraine's efforts to cover sizable external debt obligations maturing next year, and also help to anchor macroeconomic policies through the 2019 presidential and parliamentary elections.
- We are therefore affirming our 'B-/B' global scale ratings on Ukraine and 'uaBBB' Ukraine national scale ratings.
- The outlook remains stable.
On Oct. 19, 2018, S&P Global Ratings affirmed its 'B-/B' long- and short-term foreign and local currency sovereign credit ratings on Ukraine. The outlook is stable. At the same time, we affirmed our 'uaBBB' Ukraine national scale rating.
The stable outlook reflects our expectation that Ukraine's existing extended fund facility (EFF) program with the International Monetary Fund (IMF or the Fund) will be terminated early but a new 14-month program will be secured in its place. This will help anchor macroeconomic policymaking through Ukraine's 2019 presidential and parliamentary elections. We also expect that, as Ukraine makes some progress with conditionality under the new arrangement, it will be eligible for additional disbursements from international donors. This concessional funding will aid Ukraine in issuing additional commercial debt to meet its external repayments coming due over the next 12 months. Ratings pressure could build if disruptions to funding from external donors and/or the government's inability to tap capital markets over the next few months called into question Ukraine's ability to meet large external repayments over 2019. Additionally, an adverse ruling in Ukraine's legal battle with Russia over a Eurobond issued in December 2013, and held by Russia, could have fiscal implications for Ukraine, in our opinion. In a worst-case scenario, it might create technical constraints for Ukraine's ability to repay its commercial debt, which would pressure the ratings. We anticipate there will be appeals to the Supreme Court in the U.K. following the recent Court of Appeal decision in London to allow a full trial of the case, further prolonging the overall proceedings. We note that the government believes there is no potential for technical constraints on debt service, even in the case of an adverse ruling in the future. We could consider a positive rating action if economic growth significantly outperforms our expectations, alongside improvements in fiscal and external imbalances that would allow the National Bank of Ukraine (NBU) to continue easing its capital account restrictions, and if we conclude that the security situation in the non-government-controlled areas in Ukraine's east has stabilized and a further escalation is unlikely.
Our ratings on Ukraine reflect the country's weak economy in terms of per capita income and its challenging institutional and political environment, which remains heavily exposed to a lack of transparency at various government levels. Moreover, our ratings are constrained by Ukraine's large external refinancing risks, which necessitate continued compliance with its IMF program. Despite fiscal consolidation efforts, the stock of public debt is still large. It stems from costs associated with the cleanup of Ukraine's banking sector and only gradual progress in reducing the large pension fund deficit. Ukraine's high consumer price inflation is another rating weakness. Despite declining in recent months, it remains outside the NBU's target. The monetary policy transmission mechanism is also still weak because of the very high share of nonperforming loans (NPLs) in the banking sector.
Institutional and Economic Profile: A new $3.9 billion IMF program with a less demanding structural reform agenda is slated to replace the existing program
- Domestic demand continues to drive Ukraine's economic recovery. We project real GDP growth of 2.8% on average over 2019-2021.
- The slow pace of reform implementation is likely to result in the early termination of the existing IMF EFF program, but we anticipate another program, with a lighter emphasis on structural reforms, will be in place to see Ukraine through the 2019 election cycle.
- The likely outcome of the two elections next year is still unclear; a large part of the electorate remains undecided.
Ukraine is in its third year of economic recovery after real GDP contracted by 16% over 2013-2015. Domestic demand remains the main growth driver. In particular, household consumption has benefited from strong wage growth, falling unemployment, and significant remittance inflows from abroad. Investments, supported by government capital expenditure, are also growing by double digits. Over 2013-2015, real investments contracted cumulatively by over 41%, but have since rebounded, spurred by the improved macroeconomic environment and higher global commodity prices. The recovery in gross fixed capital formation has led to a rebound in imports. Moreover, rising oil and gas prices have increased Ukraine's import bill and the contribution from net exports to growth remains negative. We note that Ukraine's industrial producers, particularly in steel and aluminum, continue to partially rely on coal imports due to the suspension of trade with the separatist-controlled areas in eastern Ukraine since early 2017.
Ukrainian per capita wealth is low. Notwithstanding the nearly 20% average increase in nominal GDP since 2016, estimated per capita GDP ($2,800 in 2018) is still 70% of its 2013-level and the second lowest, after Tajikistan, in Europe and the Commonwealth of Independent States (see www.spratings.com/sri). Low income levels explain high net emigration. Over one million Ukrainians worked in Poland last year, with several hundreds of thousands in other neighboring countries. This has reportedly caused shortages of qualified labor in western Ukraine, for instance, where a successful automotive industry cluster has been establishing itself over the past few years.
We project GDP growth will average 2.8% over our forecast horizon through 2021 supported by domestic demand. Absent accelerated reform momentum, however, such a growth rate is unlikely to help Ukraine's income levels converge, even with the less advanced members of the EU. The authorities have achieved some important reforms: The NBU's independence has been preserved; previously implemented gas tariff hikes have eliminated losses at state-owned oil and gas company, Naftogaz, and markedly reduced public deficits; pension reforms have been implemented; and financial stability has been strengthened after the country's largest bank, Privatbank, was nationalized in 2016. And yet the pace of reforms under the IMF's EFF (signed in 2015) has slowed and reviews have stalled since March 2017. The establishment of an anti-corruption court (ACC) and the adjustment of domestic gas tariffs have proved stumbling blocks. Over the summer, the authorities adopted legislation on the ACC and made further changes to bring the law in line with the Venice Commission's recommendations. The ACC will process cases brought forward by the National Anti-Corruption Bureau of Ukraine. The importance of and need for an independent ACC has been highlighted by the IMF and is underpinned by Transparency International's Corruption Perception Index, where Ukraine ranks at 130 of 180 countries. Another key issue is related to gas tariffs. Under the already adopted energy tariff mechanism, Ukraine would have had to hike gas tariffs last year, but did not, partially backtracking on an already implemented reform. We understand that the government and the IMF have now reached an agreement on tariff increases with a first round 23.5% increase coming into effect on Nov. 1. Alongside the ACC legislation, this agreed tariff hike has paved the way for a new $3.9 billion IMF program, replacing the $17.5 billion program that was set to conclude in March 2019. We expect the new arrangement to be in place by the end of 2018 following parliament's adoption of the 2019 budget and the approval of the IMF's management and executive board. We understand that the new program aims to see Ukraine through the difficult 2019 election period and will help anchor policies to preserve macroeconomic stability. Given the political realities, the program will be less ambitious in pursuing ongoing structural reforms than the existing EFF. While current opinion polls favor former prime minister Yulia Tymoshenko and her Fatherland party, roughly one-half of Ukraine's population is still undecided. After the parliamentary election in October 2019, the process of building a coalition will likely be complicated. The conditions of the new IMF arrangement could then be challenged and potentially renegotiated. However, given Ukraine's limited external financing options and large foreign exchange redemptions over the next two years, we anticipate broad compliance with program requirements. Prolonged political uncertainty in 2019 may delay progress in finding a sustainable solution to the conflict in Ukraine's separatist-controlled area in the Donbas. That said, our base case assumes no further escalation of this conflict, despite frequent ceasefire violations and casualties. There is also the possibility of an escalation of tensions in the Azov Sea following the opening of the Kerch Strait bridge by Russia. The ongoing external security risk created by this conflict is a ratings constraint.
Flexibility and Performance Profile: Large external debt repayments in 2019 will necessitate compliance with the IMF program
- The IMF program will be key to unlocking external financing, without which the government's ability to service its foreign currency debt obligations in 2019 is uncertain.
- We anticipate budgetary deficits will remain broadly in line with program stipulations in 2018 and 2019 despite the upcoming elections.
- Inflation has inched closer to the NBU's target following six key policy rate hikes over the past year.
Ukraine faces substantial external debt repayments in 2019 and 2020. The government has about $5.5 billion (about 4.5% of GDP) of debt obligations, including interest, coming due in both 2019 and 2020. In addition, repayments toward government foreign currency debt in the domestic market total about $3 billion (2.3% of GDP) in 2019. Given that local banks, which are the major participants in the domestic debt market, have their own foreign currency redemptions in 2019, rollover ratios of government foreign currency-denominated domestic debt may be less than 100%. We also note that banks own nearly 30% of their assets in government bonds. Non-resident participation in the domestic bond market is currently negligible but could increase once a sales link (such as Clearstream) to the global bond market is established. This is scheduled for early 2019. We assume that Ukraine will draw about $3 billion in 2019 from the new IMF program. These inflows would go directly to boosting the foreign currency reserves at the central bank and would not be available for sovereign foreign currency debt repayments. However, we assume that the new arrangement would also unlock additional donor financing of about €1 billion from EU macrofinancial assistance and $800 million in World Bank guarantees. We also assume proceeds from fresh sovereign Eurobond issuance will cover external financing needs, as will some proceeds from hryvnia-denominated bond issuance in the domestic bond market. Together, these funds should help Ukraine meet its external foreign currency debt repayment needs in 2019. Absent the IMF funding and additional donor funds tied to the IMF program, we continue to see a risk of marked deterioration in Ukraine's external financing, given its large refinancing needs. We believe the government is unlikely to be able to raise the full amount of foreign currency financing it needs in 2019 in the domestic bond market. The government's 2019 foreign currency redemptions are sizable relative to the size of the NBU's foreign currency reserves, which were $16.6 billion as of September 2018. Despite the NBU's net foreign currency purchases through 2018, reserves have declined so far this year on the back of public sector net foreign currency redemptions. We estimate that the central bank's reserves at present cover under three months of current account payments. We think these factors increase the likelihood that the government will remain compliant with the stipulations of the new program, at least until the parliamentary elections in the fall of next year. Ukraine's external profile remains a key rating weakness. Alongside large foreign currency redemptions in 2019 and 2020, we also anticipate a widening of the current account deficit toward 4% of GDP by 2021 from about 3% in 2018 in line with a rising import bill and despite continued strong remittance inflows. Strong domestic demand, volatile commodity prices, and risks to external trade from rising global protectionism underpin these deficits. We project that these deficits will be largely covered by concessional lending to the public sector by international financial institutions, portfolio debt inflows and, less so, net foreign direct investment inflows. This funding mix will result in Ukraine's external debt net of liquid financial sector assets staying at a high 120% of CARs, with gross external financing needs averaging 135% of CARs and usable reserves over our forecast horizon. The general government fiscal deficit narrowed in 2017 to 1.6% of GDP thanks to revenue outperformance--aided by strong domestic demand and inflation--as well as budget underspending. Budgetary execution in 2018 so far has been close to balance, though spending could pick up toward year-end. We therefore project a general government deficit at 2.5% of GDP in 2018. The draft 2019 budget pencils in a general government deficit of 2.3%. We believe there is limited scope for pre-election spending given the government's reliance on external financing. On the revenue side, a proposed capital exit tax could potentially replace corporate tax. We understand that the authorities are currently considering the impact this could have on revenue intake, and is planning offsetting measures to mitigate any identified revenue shortfalls. The aim is to maintain the budget within the threshold desired by the IMF. Overall, we believe that, through 2021, the government will maintain its general government deficit at or below the IMF program's target of 2.5% of GDP. Over our forecast horizon, we also expect a mildly positive impact on Ukraine's public finances from the 2017 pension reform, which gradually increases, to 35, the years of service required to retire without a penalty. As the reform falls short of an outright increase in the statutory retirement age and some provisions may reduce incentives to work until 65, we believe Ukraine needs to make further adjustments if it is to see the large pension-fund deficit sustainably decline. Naftogaz's financial performance has helped Ukraine's fiscal position. Thanks to gas tariff hikes implemented under the IMF program in previous years, Naftogaz has reported surpluses and has recently paid dividends into the state budget. Still, further hikes to tariffs, as agreed under the IMF program, could more sustainably improve Naftogaz's financial position. Moreover, the Stockholm Court of Arbitration recently ruled in favor of Naftogaz in a lawsuit over undersupplied gas under the Naftogaz-Gazprom gas transit contract. Once the financial damages awarded to Naftogaz ($4.6 billion; 4% of GDP) in this case are netted against the claims that Gazprom has against Naftogaz--from another ruling of the Stockholm court in the so-called "take or pay" case--Gazprom will still owe Naftogaz about $2.6 billion (2% of GDP). Due to the favorable ruling of the Stockholm court, we no longer believe that contingent liabilities are a significant risk to Ukraine's debt profile. We note, however, that the gas transit contract with Gazprom expires at the end of 2019. With plans at the European level to pursue the North Stream 2 pipeline project, which would allow Gazprom to boost its direct gas exports to Europe, we think Naftogaz and therefore the sovereign could lose an important source of foreign currency revenues as well as budgetary support. General government debt to GDP is on a downward path because of Ukraine's lower fiscal deficit and strong nominal GDP growth. Despite another recapitalization of nationalized PrivatBank in 2017, Ukraine's debt ratio in 2017 fell to around 72% of GDP (81% in 2016). In line with our macroeconomic and fiscal baseline projection, we forecast that this ratio could decline further to about 57% by 2021. However, the forecast remains highly sensitive to future exchange rate developments, since around 70% of Ukrainian government debt is denominated in foreign currency. There is a residual risk for Ukraine's government balance sheet from the $3 billion Eurobond issued and bought by Russia in 2013, which was not restructured. We understand that a recent London court's decision to grant a full trial for the case is likely to ensure that a conclusion of the case may be years out. An adverse ruling and Ukraine's potential refusal to pay in full could eventually lead to legal constraints on Ukraine's ability to repay its commercial debt, although we note that the Ukraine government does not see this as a risk. Ukrainian banks continue to grapple with very high NPLs. In June 2018, the system's NPL ratio stood at 55.7%. We note this figure is exacerbated by PrivatBank, which has NPLs amounting to about 85% of its loan portfolio, due to its corporate loan book being almost entirely composed of related-party lending. This compares with NPLs of around 25% for Ukrainian private banks. The government has recently agreed on a strategy for state-owned banks, which includes a gradual cleanup and eventual privatization of at least two of the four--Oschadbank and PrivatBank. With the restructuring of all four state-owned banks progressing, we do not expect any additional recapitalization needs from the central government over the next year. A high share of NPLs points to the weak credit standing of Ukrainian companies and households and the limited number of clients with adequate creditworthiness. In our view, this still limits the transmission mechanism of monetary policy. Overall, we classify Ukraine's banking sector in group '10' ('1' being the lowest risk, and '10' the highest) under our Banking Industry Country Risk Assessment methodology (see "Banking Industry Country Risk Assessment: Ukraine, " published Jan. 8, 2018, on RatingsDirect). We view the appointment of Yakiv Smolii as the governor of the NBU as an important signal of central bank independence and its ability to continue with the cleanup of the financial sector and preserving financial stability. The NBU continues to fight inflation, with six hikes to the key policy rate to 18% since September 2017. Inflation has decelerated from14.1% in January to 8.9% in September, moving closer to but still outside the NBU's 2018 target of 6% +/- 2%. Given our forecast of continued deprecation pressures on the Ukrainian hryvnia and pass-through into domestic prices, we forecast that inflationary pressures will persist over the medium term. Broader macroeconomic stability, a more stable exchange rate, and replenished foreign exchange reserves should also enable the NBU to continue gradually easing its capital account restrictions.
|Ukraine Selected Indicators|
|ECONOMIC INDICATORS (%)|
|Nominal GDP (bil. LC)||1,405||1,465||1,587||1,989||2,385||2,983||3,404||3,782||4,215||4,689|
|Nominal GDP (bil. $)||174||180||132||91||93||112||118||127||137||148|
|GDP per capita (000s $)||3.8||3.9||2.9||2.1||2.2||2.6||2.8||3.0||3.3||3.5|
|Real GDP growth||0.2||(0.0)||(6.6)||(9.8)||2.4||2.5||3.0||2.5||3.0||3.0|
|Real GDP per capita growth||0.6||0.2||(6.3)||(4.5)||2.8||2.9||3.5||3.0||3.5||3.5|
|Real investment growth||5.0||(8.4)||(24.0)||(9.2)||20.4||18.2||6.5||5.5||7.2||7.2|
|Real exports growth||(5.6)||(8.1)||(14.2)||(13.2)||(1.8)||3.5||3.0||3.0||3.3||3.3|
|EXTERNAL INDICATORS (%)|
|Current account balance/GDP||(8.2)||(9.2)||(3.5)||1.8||(1.4)||(2.2)||(2.9)||(3.4)||(3.6)||(4.1)|
|Current account balance/CARs||(14.7)||(17.6)||(6.2)||2.8||(2.3)||(3.6)||(4.9)||(6.0)||(6.5)||(7.7)|
|Net portfolio equity inflow/GDP||0.3||0.7||(0.3)||0.2||0.2||0.1||0.1||0.2||0.2||0.2|
|Gross external financing needs/CARs plus usable reserves||134.0||146.0||154.6||173.6||147.2||135.9||130.2||135.8||135.3||135.5|
|Narrow net external debt/CARs||89.0||108.1||135.9||152.4||143.2||119.4||121.2||120.2||118.6||118.2|
|Narrow net external debt/CAPs||77.7||91.9||128.0||156.8||140.0||115.3||115.5||113.4||111.3||109.7|
|Net external liabilities/CARs||52.3||71.5||67.4||56.4||47.2||37.8||42.2||46.4||50.6||56.1|
|Net external liabilities/CAPs||45.6||60.8||63.5||58.0||46.2||36.5||40.2||43.8||47.5||52.1|
|Short-term external debt by remaining maturity/CARs||60.4||62.9||85.0||89.2||74.3||59.8||60.9||64.8||63.9||62.5|
|Usable reserves/CAPs (months)||3.2||2.4||2.7||0.9||2.4||2.3||3.1||2.9||2.9||2.9|
|Usable reserves (mil. $)||22,093||17,618||4,289||11,528||13,738||18,816||18,432||19,442||20,048||19,559|
|FISCAL INDICATORS (%, General government)|
|Change in net debt/GDP||3.7||4.7||31.8||21.8||15.3||6.1||4.6||3.6||3.4||3.2|
|MONETARY INDICATORS (%)|
|GDP deflator growth||7.8||4.3||15.9||38.9||17.1||22.0||10.8||8.4||8.2||8.0|
|Exchange rate, year-end (LC/$)||8.05||8.24||15.82||24.03||27.30||28.10||29.50||30.30||31.20||32.10|
|Banks' claims on resident non-gov't sector growth||3.0||12.8||11.8||(2.4)||(1.6)||1.2||7.0||6.0||6.5||6.5|
|Banks' claims on resident non-gov't sector/GDP||59.9||64.8||66.9||52.1||42.8||34.6||32.4||30.9||29.6||28.3|
|Foreign currency share of claims by banks on residents||32.5||29.2||40.0||48.4||38.9||32.2||47.0||47.0||47.0||47.0|
|Foreign currency share of residents' bank deposits||44.0||37.0||45.9||45.3||46.3||46.0||47.0||48.0||48.0||48.0|
|Real effective exchange rate growth||2.5||(3.0)||(21.5)||(5.8)||(1.5)||4.7||N/A||N/A||N/A||N/A|
|Savings is defined as investment plus the current account surplus (deficit). Investment is defined as expenditure on capital goods, including plant, equipment, and housing, plus the change in inventories. Banks are other depository corporations other than the central bank, whose liabilities are included in the national definition of broad money. Gross external financing needs are defined as current account payments plus short-term external debt at the end of the prior year plus nonresident deposits at the end of the prior year plus long-term external debt maturing within the year. Narrow net external debt is defined as the stock of foreign and local currency public- and private- sector borrowings from nonresidents minus official reserves minus public-sector liquid assets held by nonresidents minus financial-sector loans to, deposits with, or investments in nonresident entities. A negative number indicates net external lending. LC--Local currency. CARs--Current account receipts. FDI--Foreign direct investment. CAPs--Current account payments. The data and ratios above result from S&P Global Ratings' own calculations, drawing on national as well as international sources, reflecting S&P Global Ratings' independent view on the timeliness, coverage, accuracy, credibility, and usability of available information.|
Ratings Score Snapshot
|Ratings Score Snapshot|
|Key rating factors|
|Fiscal assessment: flexibility and performance||4|
|Fiscal assessment: debt burden||5|
|S&P Global Ratings' analysis of sovereign creditworthiness rests on its assessment and scoring of five key rating factors: (i) institutional assessment; (ii) economic assessment; (iii) external assessment; (iv) the average of fiscal flexibility and performance, and debt burden; and (v) monetary assessment. Each of the factors is assessed on a continuum spanning from 1 (strongest) to 6 (weakest). S&P Global Ratings' "Sovereign Rating Methodology," published on Dec. 18, 2017, details how we derive and combine the scores and then derive the sovereign foreign currency rating. In accordance with S&P Global Ratings' sovereign ratings methodology, a change in score does not in all cases lead to a change in the rating, nor is a change in the rating necessarily predicated on changes in one or more of the scores. In determining the final rating the committee can make use of the flexibility afforded by §15 and §§126-128 of the rating methodology.|
- General Criteria: Methodology For National And Regional Scale Credit Ratings, June 25, 2018
- Criteria - Governments - Sovereigns: Sovereign Rating Methodology, Dec. 18, 2017
- General Criteria: Methodology For Linking Long-Term And Short-Term Ratings , April 7, 2017
- General Criteria: Use Of CreditWatch And Outlooks, Sept. 14, 2009
- General Criteria: Methodology: Criteria For Determining Transfer And Convertibility Assessments, May 18, 2009
- General Criteria: Rating Implications Of Exchange Offers And Similar Restructurings, Update, May 12, 2009
Sovereign Risk Indicators, Oct. 11, 2018. An interactive version is also available at http://www.spratings.com/sri
- Sovereign Ratings History, Oct. 3, 2018
- Sovereign Ratings List, Oct. 3, 2018
- Default, Transition, and Recovery: 2017 Annual Sovereign Default Study And Rating Transitions, May 8, 2018
In accordance with our relevant policies and procedures, the Rating Committee was composed of analysts that are qualified to vote in the committee, with sufficient experience to convey the appropriate level of knowledge and understanding of the methodology applicable (see 'Related Criteria And Research'). At the onset of the committee, the chair confirmed that the information provided to the Rating Committee by the primary analyst had been distributed in a timely manner and was sufficient for Committee members to make an informed decision. After the primary analyst gave opening remarks and explained the recommendation, the Committee discussed key rating factors and critical issues in accordance with the relevant criteria. Qualitative and quantitative risk factors were considered and discussed, looking at track-record and forecasts. The committee's assessment of the key rating factors is reflected in the Ratings Score Snapshot above. The chair ensured every voting member was given the opportunity to articulate his/her opinion. The chair or designee reviewed the draft report to ensure consistency with the Committee decision. The views and the decision of the rating committee are summarized in the above rationale and outlook. The weighting of all rating factors is described in the methodology used in this rating action (see 'Related Criteria And Research').
Ratings Affirmed Ukraine Sovereign Credit Rating B-/Stable/B Ukraine National Scale uaBBB/--/-- Transfer & Convertibility Assessment B- Senior Unsecured B- Senior Unsecured D
Certain terms used in this report, particularly certain adjectives used to express our view on rating relevant factors, have specific meanings ascribed to them in our criteria, and should therefore be read in conjunction with such criteria. Please see Ratings Criteria at www.standardandpoors.com for further information. Complete ratings information is available to subscribers of RatingsDirect at www.capitaliq.com. All ratings affected by this rating action can be found on S&P Global Ratings' public website at www.standardandpoors.com. Use the Ratings search box located in the left column. Alternatively, call one of the following S&P Global Ratings numbers: Client Support Europe (44) 20-7176-7176; London Press Office (44) 20-7176-3605; Paris (33) 1-4420-6708; Frankfurt (49) 69-33-999-225; Stockholm (46) 8-440-5914; or Moscow 7 (495) 783-4009.
|Primary Credit Analyst:||Aarti Sakhuja, London (44) 20-7176-3715;|
|Secondary Contact:||Ravi Bhatia, London (44) 20-7176-7113;|
|Research Contributor:||Ashay Gokhale, Mumbai + (91)2240405817;|
|Additional Contact:||EMEA Sovereign and IPF;|
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