Fitch: Sigma Finance's 'AAA/F1+' On Watch Neg; $30B CP/MTNs Affected.

Business Editors

NEW YORK--(BUSINESS WIRE)--Feb. 14, 2002

Fitch Ratings places the 'AAA' long-term and 'F1+' short-term ratings of Sigma Finance Corp. (Sigma) on Rating Watch Negative. Approximately $30 billion of U.S. dollar- and Euro-denominated commercial paper (CP) and medium-term notes (MTNs) issued by Sigma and its wholly owned, guaranteed affiliate, Sigma Finance, Inc., are affected.

Fitch's action reflects concerns arising from Sigma's planned restructuring, which is an attempt by the investment manager, Gordian Knot Ltd., to address the structural risks that result from the entity's current and projected size. Additionally, this action is the result of concerns related to transparency and operational risk, arising from Sigma's absolute size, rate of growth, and growth objectives. In the event a rating change is made, Fitch would expect to lower the ratings to 'A' long-term and 'F1' short-term.

Sigma is planning to adopt a revised operating structure that grants significantly greater operating flexibility and eliminates existing market value-based de-leveraging and defeasance triggers, while at the same time resulting in lower levels of operating capital. The planned operating structure and the potential for lower levels of capital (particularly in a period of market stress and declining asset values) is inconsistent with the existing ratings. While Sigma maintains considerable balance sheet liquidity, its reliance on short-term, market-sensitive funding sources and continued funding access is substantially at odds with the planned structural changes. Reliance on short-term funding materially increases the likelihood that Sigma will be forced to sell assets in order to partially or fully de-lever during a period of credit and liquidity stress. While the planned restructuring may prove beneficial for Sigma's capital note holders, the changes to the program do not appear to strengthen debt-holder protection.

Sigma's current and projected size present credit concerns that are material for senior debt-holders. With $32 billion of assets under management, Sigma has grown successfully and dramatically since inception (year-over-year compounded growth in excess of 25%), and is substantially larger than its nearest competitor. Management is committed to further growth, and the program's authorized maximum size is $63 billion. Sigma's investment manager is concerned that Sigma's current defeasance structure and required capital were not constructed to support the current and projected size. While Sigma has performed well to date, the forced liquidation of its $32 billion portfolio would likely occur during a period of rising defaults, general spread widening and declining asset prices. While there is some merit to Sigma's concern, Fitch believes the proposed remedy, in fact, may raise the risk profile for CP and MTN investors. Operating with lower leverage and slowing growth may offer a superior solution to Sigma's concerns.

As an attempt to reduce the perceived defeasance risk, Sigma is undertaking a restructuring initiative that would substantially alter the operating parameters and structural triggers that have underpinned the ratings since the entity was formed in 1995. The cornerstone of the restructuring plan is the elimination of certain market value-based capital and liquidity triggers. Currently, in the event Sigma fails to maintain required capital or liquidity support (using a mark-to-market methodology for both), the entire investment portfolio is subject to early liquidation in order to ensure a complete 'defeasance' of all outstanding senior liabilities. This defeasance structure is a fundamental feature of the program, intended to serve as a 'stop loss' trigger that protects the senior debt-holders from continued market value and/or liquidity erosion.

Under the proposed structural amendments, Sigma would not be forced into defeasance upon breaching a capital, liquidity or other operating trigger. Rather, the investment manager would be permitted to continue to manage the portfolio, issue liabilities, and attempt to cure such deficiency, with only modest operational restrictions. Effectively, this structural change would grant significantly greater operating flexibility to the investment manager during a period of firm-specific or market stress when capitalization levels may also be under pressure. While the program amendments may prove beneficial to capital note-holders by eliminating the structural program termination, downside protection is weaker, the period of risk is extended and credit protection for senior debt-holders may be reduced. While the investment manager will have incentives to rectify any problems, the proposed structure lacks appropriate structural protections, as currently exist.

Sigma's restructuring plan incorporates an overhaul of the existing capital framework, which paradoxically results in lower capitalization levels, without a commensurate reduction in risk. Whereas the current capital methodology is market value-based, Sigma plans to alter its capital requirements to reflect a book value approach, which assumes all assets are held to maturity. While the current market value-based capital framework explicitly reflects the market's views on specific securities in required credit enhancement levels, this will no longer be the case under the proposed book value capital methodology. For an identical portfolio as currently constituted, required capital would be reduced (particularly during a period of credit and liquidity stress), while concurrently lengthening the credit and market risk horizon of the underlying assets indefinitely. More importantly, Sigma would not be subject to any 'stop loss' or other structural triggers to wind down the program in the event of continued erosion of capital and/or liquidity.

Sigma's reliance on short-term, market-sensitive funding sources also is inconsistent with the proposed shift to a cash flow-based 'non-defeasance' structure. Whatever benefits accrue to a non-defeasance structure, which is intended to limit ill-timed portfolio sales, are largely tied to Sigma's continued funding access or, in the event funding access is curtailed, a well-constructed contingent liquidity plan. Sigma utilizes short-term funding sources (weighted average life of less than one year) to fund its portfolio of longer-term investments. This reliance on short-term funding creates a significant refinancing risk, and makes it likely that Sigma would be forced to sell or otherwise monetize its investments in the event of a market-wide or issuer-specific funding disruption.

Given Sigma's current and projected growth, transparency and operational risk issues have also moved to the forefront as potential credit concerns. In particular, Sigma's policy of limited financial disclosure with respect to individual investments and other relevant risk measures are more of a concern under the new proposal. Fitch believes that these concerns may require changes in Sigma's risk oversight and financial disclosure, particularly in light of Gordian Knot's modest infrastructure and independent nature.

The ratings will remain on Rating Watch while Fitch closely monitors the implementation of Sigma's restructuring plan, portfolio growth and trends in capitalization and liquidity. Additionally, Fitch will assess Sigma's response to transparency and operational risk factors.