Last Updated: June 1, 2016

Country Ceiling for Structured Finance Products
There are cases in which a worsening of creditworthiness of sovereigns or restrictions onconversion of local currencies into foreign currencies/ remittances of foreign currencies may havean impact on principal and interest payments on the relevant structured finance products in terms of
the affected countries and regions. JCR takes into consideration an issuer rating of sovereign andcountry ceiling as described below in rating for structured finance products1. This draft is based onassumption that source of cash flows is located in a single country.
1.

Sovereign risk
(1) Impact on country’s economy
The past examples show that sovereign crises are accompanied by social and economic
disorders including deterioration of GDP or unemployment rate, significant fluctuations in prices,and capital drain from a country, despite differences among countries in the situations. The
central governments may directly or indirectly impose restrictions on repayment of debts inforeign currencies by private enterprises through deposit blockade or restrictions on taking
foreign currencies out of the country mainly for the purpose of stabilizing the country’s economy,
currency or financial market. As seen in Greece in 2010, there are cases in which the central
governments do not restrict foreign currency transactions even after a sovereign falls into
default due to progress of globalization.
(2) Impact on creditworthiness of structured finance products
Sovereign crises, often accompanied by worsening or disorder of economic environment, maycause a lowering of creditworthiness of parties to the structured finance product structure, aworsening of the underlying assets’ performance, or a suspension of the principal and interest
payments due to measures such as restrictions on transactions of the financial system. Theseimpacts, however, differ by the interested parties or types of underlying assets.
This is because structured finance products can flexibly meet various requests and risk
tolerances of the interested parties and investors by initial designs of structures including
underlying assets’ type or diversification, redemption schedule, parties including servicer or
financial institutions for opening a bank account, credit enhancement facilities, etc. As shown

1

This methodology includes ratings for project finance, asset finance and J-REITs. For repacked financial
instruments, credit-linked products and fully supported ABCP, JCR applies corporate rating methodology tothese ratings, because credit risk of the parties concerned is linked to the rating for structured financeproducts through weak link approach.
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by the past examples, there were cases where structured finance products successfully
averted defaults through measures taken under the structures such as setting of flexible
redemption schedule.
2.

Country ceiling in rating for structured finance products(1) Sovereigns that should be analyzed
Structured finance products are financial transactions that use structures such as a special
purpose vehicle (“SPV”) or credit enhancement mechanisms. JCR considers “cash flowanalysis,” “operational execution capabilities of parties to the structure,” and “bankruptcy
remoteness” as key points for assessment of these products. More specifically, sovereigns
where underlying assets being a source of cash flows, parties to the structure who assume
operational execution or credit enhancement mechanisms, and SPV are located, whether it isfully bankruptcy remote or not, come into question.
(i) Country where underlying assets are locatedAs an occurrence of a sovereign’s default will have a significant effect on performance ofunderlying assets of structured finance products through significant political or economic
disorders or weaknesses, JCR first considers effects from a sovereign country in which theunderlying assets are located.
(ii) Country where parties to the structure operate
In cases where servicer or financial institution for opening a bank account can no longer work
due to economic disturbance or foreign currency restrictions, it may fail to abide by payment bymaturity date or timely payment because of cash flow disruption of structured finance products.
In cases where such risk comes to the surface, effects from a sovereign country in which it
operates its services may be reduced if its operations are transferrable to a backup servicer orother financial institution.
(iii) Country where SPV is located
SPV is an entity holding underling assets, but is only used as conduit under the structured
finance product structure. For this reason, JCR considers that effects from a sovereign country
in which SPV is located are limited in the following cases:-The sovereign country is a developed country such as U.S., Eurozone countries, or Japan,
which adopts a major currency and has limited risks relating to conversion of local
currencies into foreign currencies/ remittances of foreign currencies.

-The sovereign country is an established offshore center like Cayman Islands, which has
limited risks of conversion of local currencies into foreign currencies/ remittances of foreign
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currencies.
-In cases where risks such as economic disturbance or foreign currency restrictions come tothe surface, it is possible that the structured finance transactions are transferrable toanother SPV that is established in a different country.

(2) Limitations by sovereign rating
Creditworthiness of structured finance products is directly or indirectly affected by default of asovereign country in which the underlying assets are located. Political intervention such as debt
forgiveness or deterioration in economic environment (GDP growth rate, unemployment rate,interest rates, etc.) after the default lowers in many cases performance of the underlying assets,
reducing the repayment source. If deposit blockade occurs due to turmoil of financial system,
interest payments and principal repayments by maturity date as scheduled might be difficult
even when there are sufficient funds for servicing debts.
In cases where the rating of the sovereign country in which the underlying assets arelocated is low and likelihood of the default is increasing, rating on the structured financeproducts is subject to limitations by the sovereign rating. Propriety of a rating on the structured
finance products can exceed the sovereign rating will be individually determined byconsideration of their sensitivity to the changes in environment following the sovereign’s default.
For the structured finance products, of which tolerance to such changes is considered low suchas asset-backed securities backed by consumer loans to individual customers with low
creditworthiness, namely non-prime loans, or collateralized loan obligations backed by loans tocorporations whose sales activities are limited to the country only, it is less likely that theirratings will be higher than that of the sovereign country in which the underlying assets arelocated, even if the sovereign rating is high.
If country of parties to the structure or country of SPV is different from that of underlying
assets, JCR will consider limitations by sovereign ratings for these criteria along with limitations
by sovereign rating for the underlying assets.
(3) Limitations by country ceiling
In light of relations between rating for structured finance products and country ceiling, it isnecessary to assess measures in the structure for the risk of the relevant country’s conversionof local currencies into foreign currencies/ remittances of foreign currencies, except in cases
where the structured finance transaction is completed in a single country and the structured
finance product is the country’s domestic currency-denominated one, because if conversion of
the local currency into foreign currencies or overseas remittance of the currency is restricted,
interest and principal payments on foreign currency denominated debts might be difficult. Suchrisk can be reduced by the following measures in the structure:
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-Offshore creation of reserve account-Offshore foreign currency swap or third-party guarantee/ insurance-

Flexible interest payment/ redemption schedule
It is difficult to predict what kind of restrictions can be imposed in the future in a uniform
manner, because the regulations imposed in the past sovereign or financial crises differ
from country to country and from age to age. The rating for structured finance products
therefore in principle does not exceed the country ceiling for a country where the underlying
assets are located. However, if the risk of the relevant country’s conversion of local
currencies into foreign currencies/ remittances of foreign currencies is judged as reduced
as a result of assessment of the measures for such risk in the structure, a rating exceedinga country ceiling in relation to underlying assets may be exceptionally possible.

(Reference) JCR’s Views on Sovereign Rating and Country Ceiling
Excerpt from Rating Methodology - Sovereign and Public Sector Entities (Last Updated: November7, 2014)
Sovereign Credit Rating
An issuer rating of the sovereign shows the government's ability and willingness to fulfill its debt
obligations by grading in the rating scale. A sovereign borrower is usually the government or thecentral bank, although it could vary depending on the legal norm defined by each country. Major
difference between the sovereign and the corporate is that the former has the power to levy taxes
and the right of issuing currency. It does not abide by the bankruptcy laws and could not disappear
like the latter, either. All of which are attributable to the fact that the government has sovereignty of acountry.

An individual bond rating may be different from the issuer rating as the bond could havedegrees of certainty in the repayment depending on its signed contracts, and could default
selectively. Rating symbols for sovereigns is used according to JCR's "Types of Credit Ratings andDefinitions of Rating Symbols".
Local Currency Rating and Foreign Currency Rating
A sovereign debtor has the power to levy taxes that can allow it to ensure financial sources forfulfilling its debt obligations and the right of issuing currency. For the payment of foreign currency
debts, the debtor needs to convert its local currency to a foreign currency or to procure a foreign
currency in the markets. The payment of local currency debts is hence less constrained.
Considering such difference, JCR may assign different ratings to the local currency rating and theforeign currency rating. In normal cases, the former is higher than the latter. The following factors
are taken into account for notching the difference: financial and monetary conditions of the4/5
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sovereign that can affect effectuality in the use of power to levy taxes and the right of issuingcurrency; degree of development of the domestic financial markets; level of foreign exchange
reserves; and monetary union or adoption of a pegged exchange rate regime, which could abate
constraints on foreign currencies.
Country Ceiling
A country ceiling reflects JCR's assessment of authorities' likelihood to impose restrictions on
foreign currency transactions made by a corporate entity in the country to fulfill its debt obligations,such as conversion of local currency into foreign currency and remittance of foreign currency
outside the country. It serves as a maximum limit for the entity's foreign currency rating and in mostcases is higher than the sovereign foreign currency rating.
A country ceiling only applies to a foreign currency rating. This is mainly because authorities
generally have limited capability to procure or issue foreign currency as compared to local currency.
Therefore, authorities sometimes impose restrictions on foreign currency transactions of an entity inthe country when they run into difficulties financing repayment of its debt in foreign currency.
A country ceiling will be determined, based on the overall assessment of the currency incirculation, foreign exchange regime, trade settlement and capital control, economic policies andforeign debts as well as responses to crises. In most cases, a country ceiling will be increased byzero-three notches from the sovereign foreign currency rating. However, countries like the US andJapan or in the Euro area may not come under the above criteria mainly because they adopt hardcurrencies and therefore have only limited likelihood to restrict foreign currency transactions.
In most cases, a country ceiling is a maximum limit for the foreign currency rating of an entity inthe country. However, there may be some exceptions when agreements are in place among
countries such as multilateral development banks and when strong support is provided to the entity
by its parent company outside the country.
Because of the possibility of human or mechanical error as well as other factors in the information herein, JCR makes norepresentation or warranty, express or implied, as to accuracy, results, adequacy, timeliness, completeness or merchantability, orfitness for any particular purpose, with respect to any such information, and is not responsible for any errors or omissions, or for
results obtained from the use of such information. Under no circumstances will JCR be liable for any special, indirect, incidental orconsequential damages of any kind caused by the use of any such information, including but not limited to, lost opportunity or lostmoney, whether in contract, tort, strict liability or otherwise, and whether such damages are foreseeable or unforeseeable. Information
herein is statements of opinion, and not statements of fact as to credit risk decisions or recommendations regarding decisions topurchase, sell or hold any securities such as individual bonds or commercial paper. JCR retains all rights pertaining to this document.
Any reproduction, adaptation, alteration, etc. of this document, is prohibited, whether or not wholly or partly, without prior consent ofJCR.

Japan Credit Rating Agency, Ltd.
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