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Rating Action:

MOODY'S ASSIGNS B1 SENIOR SECURED RATINGS TO HEXION'S NEW $675 MILLION CREDIT FACILITLIES; OUTLOOK REMAINS NEGATIVE UNTIL COMPLETION OF IPO

05 May 2005
MOODY'S ASSIGNS B1 SENIOR SECURED RATINGS TO HEXION'S NEW $675 MILLION CREDIT FACILITLIES; OUTLOOK REMAINS NEGATIVE UNTIL COMPLETION OF IPO

Approximately $1.3 Billion of Rated Debt Affected

New York, May 05, 2005 -- Moody's Investors Service assigned a B1 rating to Hexion Specialty Chemicals Inc.'s(Hexion) new $675 million guaranteed senior secured credit facilities ($275 million revolver due 2010 & $400 million term loan due 2011), a Caa3 rating to its $350 million preferred stock, and a speculative grade liquidity rating of SGL-2. These ratings have been assigned to Borden Chemicals Inc. until the effective date of the planned merger. Additionally, Moody's affirmed the existing debt ratings of Borden Chemicals Inc. and Resolution Performance Products LLC (RPP). These actions follow the announcement last week that Apollo Management Inc. plans to merge its wholly-owned chemical businesses -- Borden, RPP and Resolution Specialty Materials LLC -- to create Hexion. As part of the merger, Hexion shareholders will receive an extraordinary dividend of $550 million. The outlook has been returned to negative from developing. However, if Hexion completes its initial public offering as currently contemplated, Moody's would change the outlook to stable. Moody's has also withdrawn the senior issuer ratings for Borden and RPP and will withdraw the ratings on their existing credit facilities, once the new facility at Hexion is funded.

Ratings assigned:

Hexion Specialty Chemicals Inc.( Currently Borden Chemicals, Inc.)

$275 million guaranteed senior secured revolving credit facility due 2001 at B1

$400 million guaranteed senior secured term loan due 2011 at B1

$350 million preferred stock at Caa3

Ratings affirmed:

Borden Chemicals Inc.

Guaranteed senior secured credit facility at B1*

Guaranteed 2nd priority senior secured notes at B3

Senior unsecured notes and debentures at Caa1

Resolution Performance Products LLC

Guaranteed senior secured credit facility at B1*

8% guaranteed senior secured notes at B2

9.5% guaranteed senior secured notes at B3

Senior subordinated notes at Caa2

Ratings withdrawn:

Borden Chemicals Inc.

Issuer rating

Resolution Performance Products LLC

Issuer rating

*: Ratings will be withdrawn once the new Hexion facility is funded

The B2 senior implied rating of Hexion ratings reflects the benefits from the merger of Apollo's three businesses plus the recent acquisition of Bakelite from Rutgers AG. These benefits include the increased size, improved business diversity and geographic footprint, and roughly $75 million of potential synergies. This merger is occurring against the backdrop of an improving operating environment for many of the company's products, especially in epoxy resins, which has experienced a substantial improvement in profitability over the past six months due to tightness in the markets for bisphenol A and epichlorhydrin. Hexion's ratings are tempered by elevated leverage, exposure to volatile feedstock costs, limited free cash flow generation over the next 12-18 months, legacy environmental and pension liabilities from Borden, and sizable litigation exposure for a company with a levered balance sheet. While Hexion, and previously Borden, believe that current reserves are adequate, Moody's noted that the level of potential liability is unusual for a highly levered company.

The negative outlook reflects the increase in debt prior to the IPO from the issuance of $350 million of preferred stock, as well as the ability to dividend additional cash under existing indentures due to the way in which the merger is structured. If the extraordinary dividend remains roughly $200 million above the level of proceeds from the IPO, Moody's would change the outlook to stable upon completion of the IPO process. Due to the improving operating environment and lack of operating history with the RSM and Bakelite operations, as well as the further restructuring that will occur after the merger, actual result could differ materially from Moody's current estimate. If Hexion is able to successfully consolidate these businesses, and over the next year, demonstrate financial performance that would cause debt to EBITDA to fall below 5 times and free cash flow to total debt to rise above 5%, Moody's could raise the company's rating. Conversely, if financial performance is substantially weaker than currently anticipated, and debt to EBITDA remains above 6 times, Moody's would likely downgrade the current ratings.

The notching of the senior secured credit facility (rated B1) one level above the senior implied reflects the significant level of collateral coverage and the large percentage of accounts receivable and inventory in the collateral package. The company's obligations under the secured facilities will be guaranteed by all domestic operating subsidiaries and certain international subsidiaries. It will be secured by a first lien on substantially all domestic working capital and the tangible and intangible assets of its operating subsidiaries in Canada, the United Kingdom, the Netherlands and Germany, as well as a pledge of 65% of voting stock in international subsidiaries. As is typical in such facilities, the collateral of international subsidiaries only secures obligations of the respective international subsidiaries. However, Hexion expects slightly less than 50% of the term loan to be borrowed by the international subsidiaries. The terms of the credit facility have not been finalized, but there appears to be substantial room under the financial covenants, which only include a secured bank leverage test and a limit on capex; likewise a cash flow sweep is triggered only when financial performance is well below projected levels. Moody's noted that Hexion also has the ability to borrow an additional $200 million in revolving credit or term loan debt under the facility.

RPP's 8% senior secured notes are notched at the senior implied as they are contractually subordinate to the credit facility and rank above the other secured notes issued by Borden and the 9.5% secured notes of RPP. Borden's senior secured notes and RPP's 9.5% secured notes will rank equally in priority and are notched at B3. Borden's senior unsecured notes are rated Caa1, a notch below the second priority secured debt; these note holders can take comfort from the significant amount of subordinated debt and preferred stock (or potentially common equity) below them in the capital structure. The notching of RPP's senior subordinated notes (rated Caa2) three levels below the senior implied reflects the subordination to a significant amount of secured and unsecured debt. The Caa3 rating on the preferred stock reflects its inferior position to the subordinated notes. However, Moody's noted that management has a substantial incentive to remove this issue from the capital structure over the next 6 months. As mentioned above, the merger process will render the restricted payment clauses in the secured notes and subordinated notes ineffective and allow the company to declare several hundred million of additional dividends. Moody's does take some modest comfort that Apollo is less likely to utilize this ability, once it has completed the IPO.

After the merger, Hexion will be a vertically-integrated leading producer of thermoset resins, as well as a leading producer of versatic acids. The company also produces other specialty resins for coatings, inks and other applications. The company is also a leading producer of several commodity chemicals: formaldehyde, bisphenol A and epichlorhydrin. Additionally, the combined company will pursue cost reduction initiatives that are currently estimated to save the $75 million. In Moody's opinion, given the 86 facilities in the merged company, even if the projected synergies are slow to materialize, there will likely be additional cost saving opportunities from plant closures over the next several years. While the potential for meaningful cost synergies should improve the company long-term financial performance, over the near-term the restructuring costs will likely reduce the free cash flow available for debt reduction.

In Moody's opinion, on a pro forma basis Hexion generated roughly $326 million of EBITDA for the LTM ending December 31, 2004; Moody's estimate does not include synergies from the transaction and certain expenses or income that management has excluded or included in their calculation of pro forma EBITDA. Based on the pro forma total debt of $2,360 million (this assumes that the IPO is successfully completed), this would generate a 7 times debt to EBITDA multiple as of year-end. In Moody's opinion, this multiple would likely fall to roughly 6.5 times if measured at the end of the first quarter due to the improving profitability at RPP and to a lesser extent Borden. Furthermore, Moody's believes that this ratio could fall toward 5 times by the end of 2005, demand in the company's major end markets remain healthy. However, due to restructuring expenses and other normal legacy costs from Borden, Moody's projects that free cash flow is likely to remain constrained at less than $50 million. Due to continued exposure to volatile raw material costs and continued restructuring costs, free cash flow may continue to trail the increase in EBITDA into 2006.

The SGL-2 rating indicates good liquidity. Hexions's liquidity is supported by its expected ability to generate positive free cash flow, full availability under its $275 million committed bank facility, a favorable debt maturity profile, and the expectation that credit metrics will greatly exceed the financial covenants in its credit facility and term loan over the next five quarters. Asset sales are not expected to be a significant source of liquidity in the near term. Moody's notes however that a decline in anticipated annual free cash flow to less than $20 million, or a reduction in either cash balances (pro forma at over $50 million) or adjusted EBITDA headroom on the financial covenants could result in a lower liquidity rating.

Hexion Specialty Chemicals, Inc., headquartered in Columbus, Ohio is a leading producer of commodities such as formaldehyde, bisphenol A and epichlorhydrin, as well as formaldehyde-based thermoset resins, epoxy resins, and versatic acid and its derivatives. The company is also a supplier of specialty resins for inks and specialty coatings sold to a very diverse customer base. Hexion was formed from the merger of Borden Chemicals Inc., Resolution Performance Products LLC, Resolution Specialty Material LLC and the Bakelite Group. On a proforma basis the company would have reported sales of $4.1 billion as of December 31, 2004.

New York
Mark Gray
Managing Director
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

New York
John Rogers
Senior Vice President
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

No Related Data.
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