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Rating Action:

Moody's Assigns Ratings of Baa3 and Aa2.mx to State of Mexico's Upcoming MXN 2 billion Municipal Lending Program

 The document has been translated in other languages

Global Credit Research - 27 Aug 2010

Mexico, August 27, 2010 -- Moody's de Mexico has assigned a rating of Aa2.mx (Mexico National Scale Rating) to the State of Mexico's upcoming MXN 2 billion Municipal Lending Program. Moody's Investors Service has assigned a rating of Baa3 (Global Scale, Local Currency) to this program.

Within this program, Banobras, the lender, will grant individual loans to municipalities that join the program, which will be paid by a trust (Ixe as trustee) that will receive earmarked federal transfers from the Municipal Social Infrastructure Fund (FAISM). The trust will receive FAISM transfers via an irrevocable instruction to the Mexican Treasury (TESOFE).

Municipalities that access the lending program will sign individual loan agreements with Banobras and adhere to the trust agreement. The loans will carry a fixed interest rate and the maximum maturity will coincide with the end of current municipal administrations (November 2012). The amount of each loan will vary according to the FAISM amount available when each loan contract is signed. Accordingly, the global amount under the lending program, which was originally estimated to be around MXN 2 billion, is currently estimated at around MXN 1.6 billion.

The ratings assigned are based on documentation received by Moody's as of the rating assignment date. While individual loan contracts within the program will be signed during 2010 by municipalities, Moody's does not expect changes to the program structure over this period. In the event that the program structure changes from the documentation submitted to us, Moody's will assess the impact that these differences may have on the ratings and act accordingly.

Rating Rationale:

The Baa3/Aa2.mx ratings assigned to the lending program reflect the underlying creditworthiness of the State of Mexico (Ba2/A2.mx) supported by the following legal and credit enhancements:

- Trust structure and the irrevocable instruction to TESOFE reduce the probability of a municipality successfully interfering with the flow of funds. Furthermore, the earmarked nature of FAISM, which can only be used for capital projects and debt service, greatly limits the incentive for municipalities to attempt to divert these flows, in the event of a crisis, to cover current expenditures.

- In contrast to participation transfers, which are vulnerable to economic fluctuations and displayed significant volatility during the recent economic downturn, FAISM transfers are more stable and less exposed to fluctuations. Specifically, the exact level of annual FAISM transfers is fixed each year in the federal budget.

- Moreover, the Fiscal Coordination Law establishes that the amount of FAISM transfers available to municipalities for debt service is the greater of either: 25% of FAISM transfers in any given year or 25% of FAISM in the year that the loan is acquired. This effectively sets a floor for funds flowing into the trust.

The assigned ratings also take into account the following credit challenges:

- The pledged FAISM transfers are structured to provide debt service coverage ratios of at least 1x in both base case and stress scenarios.

- The loan structure does not include a dedicated reserve fund to mitigate against possible delays in the technical transfer of FAISM to pay debt service.

Although these risks constitute credit challenges, they are offset by the following considerations:

- Given that FAISM amounts for this year have already been fixed in the 2010 federal budget, which establishes a floor for flows to the trust, FAISM transfers would need to drop by more than 75% in order to negatively impact the 1x debt service coverage ratios.

- The lack of an explicit reserve fund is compensated by a grace period feature that tolerates 3 cases of missed debt service payments, if they are made up before the next payment period without penalties. This flexibility, in conjunction with TESOFE's strong history of timely payment, provides a cushion against the possibility of a technical delay in the transfer of FAISM to the trust or from the trust to the lender. Moreover, the short maturity profile of the program (less than three years) further mitigate these risks.

The last rating action with respect to the State of Mexico was taken on May 12, 2010 when issuer ratings were upgraded to Ba2 (Global Scale, local currency) and A2.mx (Mexico National Scale Rating) from Ba3 and A3.mx.

The principal methodologies used in rating the State of Mexico were "Regional and Local Governments Outside the US" and "The Application of Joint Default Analysis to Regional and Local Governments," published respectively in May 2008 and December 2008 and available on www.moodys.com in the Rating Methodologies sub-directory under the Research & Ratings tab. Other methodologies and factors that may have been considered in the process of rating this issuer can also be found in the Rating Methodologies subdirectory on Moody's website.

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Information sources used to prepare the credit rating are the following: parties involved in the ratings, parties not involved in the ratings, public information, confidential and proprietary Moody's Investors Service's information and confidential and proprietary Moody's Analytics' information.

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Please see ratings tab on the issuer/entity page on Moodys.com for the last rating action and the rating history.

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Please see the Credit Policy page on Moodys.com for the methodologies used in determining ratings, further information on the meaning of each rating category and the definition of default and recovery.

Mexico
Maria del Carmen Martinez-Richa
Asst Vice President - Analyst
Sub-Sovereign Group
Moody's de Mexico S.A. de C.V
Telephone:+52-55-1253-5700

London
David Rubinoff
MD - Sub-Sovereigns
Sub-Sovereign Group
Moody's Investors Service Ltd.
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Moody's de Mexico S.A. de C.V
Ave. Paseo de las Palmas
No. 405 - 502
Col. Lomas de Chapultepec
Mexico, DF 11000
Mexico

Moody's Assigns Ratings of Baa3 and Aa2.mx to State of Mexico's Upcoming MXN 2 billion Municipal Lending Program
No Related Data.
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