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Rating Action:

Moody's assigns Army and Air Force Exchange Service first time Issuer Rating at Aa2

Global Credit Research - 10 Jan 2011

New York, January 10, 2011 -- Moody's Investors Service today assigned a first time rating to Army and Air Force Exchange Service ("the Exchange"); long term issuer rating at Aa2. The rating outlook is stable.

RATINGS RATIONALE

Moody's considers the Exchange to be a Government Related Issuer ("GRI") given its status as a Non-appropriated Fund Instrumentality ("NAFI") of the U.S. Government. As a result, the Exchange's ratings are a function of both its credit profile as a stand-alone entity (reflected in its Baseline Credit Assessment) as well as the rating lift it receives due to its GRI status and the potential support it could receive from the U.S. Government.

The Exchange's Baseline Credit Assessment ("BCA") of 7 (mapping to an A3 senior unsecured rating equivalent) is reflective of its government-mandated mission, and the strong franchise it enjoys as the dominant retailer allowed to operate on all US Army and Air force bases. The rating also reflects its broad merchandise offerings, its history of consistent merchandise revenues even during the recent recession, and its ability to offset operating costs and risks as a result of being a government entity. It also reflects the very low profitability of its retail operations, but the solid earnings contributions of its credit card business and fees from franchises granted to other retailers and foodservice operators.

The Exchange's long term issuer rating of Aa2 reflects the BCA of 7, the U.S. government rating of Aaa, and Moody's assessment that the Exchange's dependence on the U.S. government is very high and the likelihood of extraordinary government support from the U.S. government would be high if such support was ever needed. The Exchange does not receive a direct guarantee from the U.S. government. However, its activities contribute heavily to the overall well-being and morale of the U.S. Army and Air Force. Given this, Moody's believes that a high priority would be placed on enabling the Exchange to continue regular operations under conditions of stress.

The rating outlook is stable. The stable outlook reflects Moody's view that that the Exchange's underlying operating performance, the powerful underlying franchise with the US military, and the benefits inherent in its effective ownership by the US government are unlikely to be materially altered in the near term. In addition, the stable outlook reflects Moody's expectation that the size of the U.S. military, which directly correlates with the Exchange's operating performance, will not materially change in the near term.

The following rating is assigned:

Long term Issuer Rating at Aa2

This is a first time rating for the Exchange.

An upgrade of the Exchange's Issuer Rating in unlikely in the near to intermediate term as there is no current indication that it would receive increased support from the U.S. government and by the fact that its Issuer Rating is not very sensitive to an upgrade in the BCA. However, the Exchange's Issuer Rating would be upgraded should the U.S. government provide a guarantee of all of its obligations. An upgrade of the Exchange's BCA would require a notable improvement in the profitability of its retail operations such that they significantly contribute to its earnings. Quantitatively, an upgrade would also require debt to EBITDA to be sustained below 2.75 times and EBITA to interest expense to remain above 7.5 times.

The Exchange's Aa2 Issuer Rating is highly sensitive to the assumptions made about support from the U.S. government. The Exchange's Issuer Rating could be downgraded should the U.S. government rating of Aaa be downgraded, should support from the U.S. government become less likely, or should its BCA of 7 be downgraded. The Exchange's BCA of 7 could be downgraded should there be a meaningful reduction in the size of active duty personnel of the Army or Air Force, should its operating performance decline, should the quality of the credit card portfolio erode, or should the benefits from the Exchange's unique mission and franchise change. Quantitatively, the Exchange's BCA could be downgraded should EBITA to interest expense fall below 6.5 times or should its debt to EBITDA rise above 3.75 times.

The principal methodologies used in this rating were Global Retail Industry published in December 2006, and Revised Methodology for Government Related Non-Bank Financial Institutions published in August 2006.

The Army and Air Force Exchange Service is a Nonappropriated Fund Instumentality of the U.S. Government. The Exchange's core mission is to provide active duty and retired military members and their dependents quality goods at competitively low prices, and to generate earnings which provide a dividend to the Army and Air Force's morale, welfare, and recreation programs. The Exchange provides a broad selection of merchandise through retail facilities and internet sites, as well as entertainment and prepared food services. The Exchange also offers and manages a low-rate credit card which can only be used within military stores. Annual merchandise sales are about $8.3 billion and franchise and finance revenues are about $500 million. The Exchange operates about 3,100 facilities in the U.S. and 30 other countries. Approximately 63% of retail revenues were generated in the U.S., 14% in the Pacific Rim (including Alaska and Hawaii), 10% in Germany, and 10% in active combat-type zones in the Middle East.

REGULATORY DISCLOSURES

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

Moody's Investors Service considers the quality of information available on the issuer or obligation satisfactory for the purposes of assigning a credit rating.

Moody's adopts all necessary measures so that the information it uses in assigning a credit rating is of sufficient quality and from sources Moody's considers to be reliable including, when appropriate, independent third-party sources. However, Moody's is not an auditor and cannot in every instance independently verify or validate information received in the rating process.

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

The date on which some Credit Ratings were first released goes back to a time before Moody's Investors Service's Credit Ratings were fully digitized and accurate data may not be available. Consequently, Moody's Investors Service provides a date that it believes is the most reliable and accurate based on the information that is available to it. Please see the ratings disclosure page on our website www.moodys.com for further information.

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.

New York
Margaret Taylor
VP - Senior Credit Officer
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

New York
Peter H. Abdill, CFA
MD - Corporate Finance
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Moody's Investors Service
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Moody's assigns Army and Air Force Exchange Service first time Issuer Rating at Aa2
No Related Data.
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