What’s Up with Ratings? CFA Society of Orlando Citrus Club Downtown November 20, 2013

1. What’s Up with Ratings? CFA Society of Orlando Citrus Club Downtown November 20, 2013 James H. Gellert, Chairman and CEO @JamesHGellert, @RapidRatings

2. What we’ll cover Agenda • Ratings – how we got here • What’s happened to the industry? • How it is changing (or not)? • Competition • Approaching things differently – Rapid Ratings • Efficacy, case studies • Immediate capital markets’ importance

3. Brief History What’s With This Industry? • It’s old!

4. Brief History What’s With This Industry? • It’s old! • Fitch 1923; Moody’s 1900; Standard & Poor’s 1906 and 1860 • Rating ability to pay back debt, default probability and loss given default • Was “subscriber-paid,” then turned to “issuer-paid” in the 1970s • The stated objective, and the rub • To help investors. But they are most particularly a help to issuers • Myriad problems result • Legislative and regulatory scrutiny • Senate: • 2002, 2005, 2006, 2009 • House of Representatives: • 2007, 2008, 2009, 2011, 2012 • SEC: • 2002, 2003, 2008, 2009, 2013

5. Problems and Solutions(?) Many problems, not many solutions • The industry has been “oligopolized” • Institutionalized, embedded in regulation and in practice • Arbitraged, manipulated, encouraged • Incumbents have had ethical and procedural lapses • Standards abandoned for commercial objectives • Incumbents creatively inhibit competition • Solutions, sort of… • 2006 Credit Rating Agency Reform Act - Nationally Recognized Statistical Ratings Organizations (“NRSRO”) • Dodd-Frank’s ratings language • 939A, Franken Amendment • But… NRSRO codification, protection of the incumbents, window dressing, competition-hindering requirements, admin and compliance burdens, increased legal liability

6. Irony or Hypocrisy? Department of Justice Office of Public Affairs FOR IMMEDIATE RELEASE Tuesday, February 5, 2013 Department of Justice Sues Standard & Poor’s for Fraud in Rating Mortgage-Backed Securities in the Years Leading Up to the Financial Crisis Complaint Alleges that S&P Lied About its Objectivity and Independence And Issued Inflated Ratings for Certain Structured Debt Securities. • Joined by 16 states: AZ, AR, CA, CO, CT, DE, DC, ID, IL, IA, ME, MS, MO, NC, PA, TN & WA (and NJ followed recently) • BUT CA, CO, IA, PA, TN, NJ all mandate the use of S&P; e.g.: “From the most general perspective, 88 percent of the total fixed income portfolio must be invested in investment grade securities. Investment-grade securities are those fixed income securities with a Moody’s rating of Aaa to Baa or a Standard & Poor’s rating of AAA to BBB. Each portfolio is required to maintain a specified risk level.”* *http://www.calpers.ca.gov/eip-docs/about/pubs/cafr-2012.pdf; page 5

7. Competition The Big Three Plus • NRSROs • 10 NRSROs after 2006 CRA Reform Act • How many now? • Different models • Issuer-paid, user-paid, investor-owned, public utility, and others • Different strategies • Replicate the traditional model • Approach differently • Asset class makes a difference • Structured products are the most different of all • 10

8. Rapid Ratings Different Business Model, New Perspective • User-paid, not issuer-paid • Independent, quantitative, scalable, timely • Three years earlier than Moody’s • Debt issuers and non-debt issuers rated • Financials only, no management input, no market signals • Financial Health Ratings • Non reductionist approach • Wide variety of performance measures • Public & private companies globally rated on apples-to-apples bases • Currently rating: • 12,000 public firms globally, and growing • 10,000 private firms for clients on a confidential basis, and growing

9. Business Segments and Uses Financial Services Segment Corporate Services Segment Enterprise risk management Investment portfolios Counterparty risk A/R management New customer evaluation Acquisition due diligence Supply chain risk management Lenders’ credit decisions and oversight Credit & equity risk management Credit & equity investing Insurance underwriting Assessing CLOs Broker/dealer trading M&A analysis Indexing Vendor risk management Commercial tenant risk assessments Single name, sector & portfolio analysis Fiduciary & regulatory oversight Traditional Ratings Research Portfolio Analytics Corporate Risk

10. Performance vs. Default Through the Financial Crisis’ High Volatility, FHRs Continued to Perform Exceptionally Well as Predictors of Corporate Health and Failure US Industrial Defaulters, 1991 to 2012 At default… 25 was the average FHR 90% of firms were High Risk or below 99%were below investment grade 66% were consistently rated High Risk or Very High Risk for at least 18 months prior 33% experienced a significant downgrade of 10 or more points in the 18 month period prior Red shows 1,124 industrials under coverage that defaulted or filed for bankruptcy.

11. Performance vs. Equities Enhanced Returns Rapid Ratings constructed a blue-chip portfolio and evaluated its performance using FHRs against a broad equity index (the S&P 500) to determine our performance. Result:

12. CFA TEST MF Global Rapid Ratings gave more than 2 years of early warning

13. Twitter Tracking Twitter’s Financial Health Rapid Ratings’ FHR on Twitter is 19. Facebook was rated 73 at IPO, and LinkedIn 69. To understand Twitter’s IPO, we created an IPO profile to match it against Bubble-era companies versus contemporary IPOs. Twitter’s profile more closely matches the IPOs of the 1997-2000 period than any time since, making Twitter indeed a Bubble-era type IPO. 13

14. Individual Company Analysis FHR Report “The rating continues to depict a Very High Risk credit profile as overall profitability, debt service management, cost structure and sales performance are at low levels relative to the global data set. “The bottom line: Notwithstanding the recent upgrade, Patriot Coal Corp is situated in our Very High Risk group, displays weakness in four of our six performance categories and demonstrates significant underperformance in ROCE. This suggests that to those for whom Patriot Coal Corp represents an existing exposure, such exposure should be very closely monitored. For those considering Patriot Coal Corp as a new or increased exposure, great caution is needed.” 14

15. Bond Market – Maturity Wall US High Yield Comparison Graph, Q4'09 to Present

16. Lev Loans: Maturity Wall Leveraged Loans Index Maturity Profile ($mn)

17. Summary An Industry in Need of Change • Ratings are an entrenched part of the capital markets • Banks will deemphasize use, but pensions will drive change • The markets need new ways of looking at risk • Some change is happening, but it’s slow • More competition is needed and awareness of unintended consequences • More access to data/information • Less focus on administration/compliance • Less focus on legal liability • Competition can grow and succeed irrespective • New players must be nimble and prove value • Ethical standards are needed to restore confidence

18. Contact Details James H. Gellert Chairman and CEO Rapid Ratings International Inc. 86 Chambers Street, Suite 701 New York, NY 10007 Tel: 646-233-4600 gellert@rapidratings.com @JamesHGellert, @RapidRatings Disclaimer: A Financial Health Rating (FHR™) or equity recommendation from Rapid Ratings™ is not a recommendation or opinion that is intended to substitute for a financial adviser's or investor's independent assessment of whether to buy, sell or hold any financial products. The FHR™ is a statement of opinion derived objectively through our software from public information about the relevant entity. This information and the related FHR’s™ and related analysis provided in the reports by Rapid Ratings™ do not represent an offer to trade in securities. The research information contained therein is an objective and independent reference source, which should be used in conjunction with other information in forming the basis for an investment decision. Rapid Ratings™ believes that all of its reports are based on reliable data and information, but Rapid Ratings™ has not verified this or obtained an independent verification to this effect. Rapid Ratings™ provides no guarantee with respect to the accuracy or completeness of the data relied upon, nor the conclusions derived from the data. Each FHR™ is a relative, probabilistic assessment of the credit risk of the relevant entity and its potential to meet financial obligations. It is not a statement that default will or will not occur given that circumstances change and management can adopt new strategies. Reports have been prepared at the request of, and for the purpose of, the subscribers to our service only, and neither Rapid Ratings™ nor any of our employees accept any responsibility on any ground whatsoever, including liability in negligence, to any other person. Finally, Rapid Ratings™ and its employees accept no liability whatsoever for any direct, indirect or consequential loss of any kind arising from the use of its ratings and rating research in any way whatsoever, unless Rapid Ratings™ is negligent in misinterpreting or manipulating the data, in which case, our maximum liability to our client is the amount of our fee for the report.