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Rating Action:

MOODY'S DOWNGRADES UNION CARBIDE'S SR. UNSECURED DEBT TO B1; OUTLOOK NEGATIVE

05 Sep 2003
MOODY'S DOWNGRADES UNION CARBIDE'S SR. UNSECURED DEBT TO B1; OUTLOOK NEGATIVE

Approximately $ 1.3 Billion of Debt Securities Affected.

New York, September 05, 2003 -- Moody's Investors Service has downgraded the senior unsecured debt of Union Carbide Corporation (Carbide) to B1; Carbide's rating outlook is negative. Moody's also affirmed the A3 rating on The Dow Chemical Company, and reiterated the company's negative rating outlook.

The downgraded reflects the absence of a guarantee from its parent company The Dow Chemical Company (Dow), uncertainty over the financial impact of asbestos related liabilities, lack of access to credit from any independent source, and the substantial reduction in Carbide's operating assets. The B1 ratings incorporate limited support from Dow, a better and more diversified product portfolio than most olefin producers, the improving fundamental in several downstream ethylene derivative markets, and the anticipation of increased dividends from its Equate and Optimal joint ventures. These ventures have access to low cost feedstocks and Optimal is well placed to take advantage of the tightening supply/demand balance for ethylene glycol in Asia.

The negative outlook reflects limited visibility with regard to the company asbestos liabilities and the concern that lawsuits and settlement payments could significantly increase over the next few years. In addition, it reflects uncertainty over Dow's willingness to continue to support Carbide, if these liabilities increase significantly or if insurance reimbursements fail to materialize.

Moody's believes that the size of Carbide's asbestos liability relative to its operating assets is a significant concern. While these liabilities are largely offset by a large insurance receivable, the lack of detailed information on the nature and terms of the insurance reimbursements raises uncertainty over the timing of cash receipts from insurance relative to settlement payments. Carbide hired a well known firm to generate an estimate of its future asbestos-related liabilities. However, Moody's believes that the lack of detail on trends in new cases, pending cases, and settlement costs per claim increases the uncertainty over the size and timing of payments related to future asbestos settlements. Although, Carbide has increased the disclosure on its asbestos-related balance sheet accounts, Moody's has limited information on which to estimate future trends.

The B1 rating reflects Moody's belief that Dow will continue to support Carbide unless it is overwhelmed by the combination of rising settlement costs and the exhaustion of insurance coverage, or the inability to obtain insurance reimbursements. At the end of the second quarter, Carbide's potential insurance coverage was roughly $1.47 billion. Additionally, Carbide's non-current asbestos-related liabilities account declined by roughly $160 million, an indication that settlement activity was elevated in the first half. Likewise, its total insurance receivable declined by roughly $95 million, indicating that Carbide is receiving reimbursements from its insurers.

Carbide's new litigation strategy, which was implemented last year, involves litigating its asbestos claims unless it makes strategic or economic sense to settle. Moody's believes that this strategy will slow the outflow of cash and ultimately result in lower settlement costs over the intermediate-term. In 2002, Carbide was the only company to go to trial in the state-wide mass asbestos litigation in West Virginia. Although Carbide was found liable, the timeframe for Carbide's product liability was significantly narrower than anticipated. Moody's believes that the outcome of this trial facilitated Carbide's settlement of a similar state-wide asbestos litigation in Virginia. Carbide's insurance is covering the majority of its asbestos litigation costs.

Carbide's liquidity is provided by a one year $1 billion secured credit facility provided by Dow. In addition to the facility's short tenure, Dow has the ability to demand repayment upon 30 days written notice. At the end of the second quarter, there was over $300 million outstanding under this facility. Moody's believes that the terms of this facility are more restrictive than most third party committed facilities; however Moody's is uncertain as to Carbide's ability to obtain sufficient financing from an independent third party.

Since the acquisition of Carbide by Dow in 2001, Carbide's operating asset base has been significantly reduced and Carbide is much more reliant on Dow for its financial performance. Carbide has exchanged most of its international operating assets, including the recently completed Joffre Canada plant, in exchange for minority equity stakes in Dow's respective international subsidiaries. While these exchanges facilitated the operational synergies between Dow and Carbide, Moody's believes that the minority equity ownership materially limits Carbide's control over cash flows generated by these assets and Carbide's ability to leverage these assets. In addition, Carbide is in the process of shutting down approximately 50% of its US ethylene capacity. While Carbide and Dow believe that they can source ethylene at a lower overall cost due to the age of these facilities and their reliance on gas feedstocks, Moody's believes that this action will further increase the company's intermediate-term reliance on Dow for its production economics. Furthermore, due to the consolidation of Carbide's and Dow's US sales and marketing operations, Dow has become Carbide's primary customer accounting for 90-95% of sales.

The integration of Dow's and Carbide's operations has generated significant synergies for the combined companies, but greatly increased Carbide's reliance on Dow for its liquidity and financial performance. Moody's believes that the combination of the uncertainty over Carbide's potential asbestos-related liability, Carbide's critical reliance on Dow for liquidity, and Moody's concern that Dow may not support Carbide under adverse circumstances greatly impair Carbide's credit profile and liquidity.

Moody's believes that Carbide's asbestos liabilities and the availability of insurance reimbursements will drive future rating actions. If either current asbestos-related liabilities or current asbestos-related insurance receivables increase by several hundred million in any one quarter or as non-current asbestos related insurance receivables fall below $700-800 million, Moody's could take additional negative rating actions. Conversely, if federal legislation is passed that would greatly reduce uncertainty over Carbide's ultimate asbestos-related liability, Moody's could reassess the appropriateness of the B1 senior unsecured ratings.

Moody's affirmed the A3 senior unsecured rating of Dow and reiterated its negative outlook. Although Dow's second quarter financial performance improved significantly and Moody's anticipates that the company will be able to generate $700-800 million in free cash flow in 2003. Moody's remains concerned that the industry fundamentals remain weak, especially in the ethylene chain, and that financial expectations for 2004 and 2005 may have to be lowered. If Moody's believes that Dow may not be able to significantly reduce debt over the next 12-24 months, Moody's could reassess the appropriateness of it's A3 ratings.

Ratings downgraded:

Union Carbide Corporation -- senior unsecured debt to B1 from Baa2

Headquartered in Midland, Michigan, The Dow Chemical Company is a diversified chemicals and plastics producer that generated over $27 billion of revenues in 2002. Union Carbide, headquartered in Danbury, Connecticut, is a wholly-owned subsidiary of Dow. Union Carbide's 2002 revenues totaled $4.8 billion.

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

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