Moody’s affirms Norske Skog’s ratings following revised exchange offer; (P)Ca and (P)C ratings remain unchanged

Moody‘s Investors Service, has affirmed Norske Skogindustrier ASA’s (Norske Skog) Corporate Family Rating (CFR) at Caa3 and the Probability of Default Rating (PDR) at Ca-PD. Moody’s also affirmed Norske Skog’s Ca (LGD5) ratings of the legacy senior unsecured notes due 2016, 2017 and 2033, the Caa2 (LGD2) rating of the EUR290 million senior secured notes due Dec-2019 issued by Norske Skog AS, as well as the Caa3 (LGD3) rating of the senior unsecured notes due 2021 and 2023, issued by Norske Skog Holdings AS. The outlook on all ratings is negative.
The provisional (P)Ca (LGD 5) rating of the proposed senior unsecured Exchange Notes due December 2026 and provisional (P)C (LGD 6) rating of the senior subordinated Perpetual Notes issued by Norske Skog remain unchanged.
The rating action follows Norske Skog’s recently revised debt exchange offer that was launched to all holders of the 2017 notes which, if executed successfully, would qualify as distressed exchange under Moody’s definition. The new exchange offer expires at 12 noon GMT on Wednesday 6 April. Upon successful conclusion of the transaction, Moody’s expects to assign a “/LD” indicator to the company’s PD rating. The other provisional ratings (P)Ca senior unsecured notes rating of Norske Skog and (P)Caa1 senior secured notes rating of Norske Skog AS) assigned prior to the recently revised exchange offer are withdrawn.

RATINGS RATIONALE
Norske Skog has decided to terminate the exchange offer of 2016 senior secured notes and to proceed with the exchange offer of the 2017 senior secured notes. The previous exchange offer has been amended and the holders of the 2017 senior unsecured bonds are offered to receive 46.8% (increased from previously 26.4%) of nominal value as unsecured exchange notes due 2026 bearing a cash interest rate of 3.5% (unchanged) and a PIK interest rate of 3.5% (unchanged), a 36.2% (unchanged) of nominal value as perpetual exchange notes, bearing 2% interest subject to deferral rights (unchanged). The 2017 holders also have the right to subscribe to 6.877% from previously 4.418% of nominal value in cash for ordinary shares of Norske Skogindustrier ASA at a price of NOK 2.24 (unchanged).

While the revised transaction addresses the 2017 maturities, the procurement of sufficient funding in time for the repayment of the equivalent NOK 1,044 million 11.75% notes maturing in June-2016 (now excluded from the revised offer) is highly uncertain and could otherwise result in a default. Liquidity remains tight even after a successful exchange and envisaged rights issue as Norske reported a further reduction in liquidity as per December 2015 to NOK 536 million from NOK699 million as per September 2015. In addition, the exchange offer is expected to only result in a pro-forma total debt reduction of up to around NOK180 million (down from NOK800m previously envisaged) in case of full participation, and given the currently very weak profitability the effect on pro forma leverage will be modest.

The Caa3 CFR and negative outlook reflects Norske Skog’s weaker than expected profitability and cash flow generation in 2015. Its high exposure to the mature publication paper market in Europe and Australia weighs on the company’s ability to improve profitability. Recently announced investments in growth projects, namely biogas and tissue production as well as the acquisition of a New Zealand-based wood pellet production to diversify away from the traditional publication paper market are not sufficient to materially offset challenging market conditions in its paper operations. We note that these investments will only moderately improve profit generation over time. Nevertheless, the incremental profits from the investments as well as slight improvements in paper prices during 2016 should help to improve profitability, which subject to the reduction and extension of near-term maturities would ease the immediate refinancing pressure until 2019 and would therefore be credit positive.

The continued weak profitability is reflected in a negative EBITDA as adjusted by Moody’s as of LTM ending September 2015. Also, Moody’s forecasts that despite recent capacity reductions in newsprint and magazine production capacity, demand for publication paper will continue to decline in the coming years. Historically, pricing power has been subdued while raw material costs remain elevated and add pressure to profitability and cash generation. This will make it challenging for Norske Skog to materially improve profit and cash flow generation and to meaningfully reduce its debt load to more sustainable levels. However, for the period of 2016 we expect a recovery in the group’s profitability levels due to improvements in paper prices which could help stabilize Norske Skog’s liquidity profile.

STRUCTURAL CONSIDERATIONS
Pursuant to the revised debt exchange offer, the Caa2 rated EUR290 million senior secured notes issued by Norske Skog AS is rated 1 notch above the CFR, reflecting the relatively higher recovery expectations compared to the structurally and contractually subordinated legacy unsecured exchange notes and the remaining unsecured legacy notes. This is because the secured notes enjoy first priority ranking pledges over assets and bank accounts, land charges on lands and buildings from Australian and New Zealand subsidiaries as well as upstream guarantees from all material subsidiaries. The Caa3 rating of the senior notes maturing in 2021 and 2023 is in line with the CFR and reflective of the junior ranking to the sizeable amount of secured bonds but seniority over the remaining portion of the unsecured debt due to upstream guarantees from operating entities, placing them ahead of other unsecured debt at the holding company level, namely the legacy 2016, 2017 and 2033 as well as the proposed new (P)Ca rated senior unsecured exchange notes due 2026. Lastly, the proposed perpetual notes are contractually subordinated to all other debt in the group and therefore rated (P)C.
The above instrument ratings are based on the assumption of a full participation by the 2017 note holders and are therefore subject to the level of participation and final outcome of the offer.

Outlook
The negative outlook reflects that a default continues a likely threat in the near term and that a failure of the exchange offer and/or failure to procure sufficient funding to repay the debt maturing in June 2016 could be credit negative with potentially weaker recovery prospects for creditors in case of disorderly default.

What could change the rating up/down
The outlook could be stabilized if the 2017 debt maturity was successfully refinanced, sufficient funding for the June 2016 maturity procured and Norske Skog was able to improve its profitability to sustainable levels and generate meaningful positive free cash flow allowing the company to de-leverage over time. However, given Norske Skog’s highly leveraged capital structure and diminished profitability and cash flow generation, Moody’s considers that an upgrade of the ratings would require substantial profit improvement and increase in cash-flow generation for considering a potential upgrade.
Conversely, the rating of the CFR and the existing bonds could be downgraded if the exchange offer does not attract sufficient interest from existing bondholders, and therefore would heighten the company’s refinancing risk towards its June 2016 debt maturity with the risk of a disorderly payment default and a bankruptcy, which could imply low recovery prospects for creditors.
The principal methodology used in these ratings was Global Paper and Forest Products Industry published in October 2013. Please see the Ratings Methodologies page on www.moodys.com for a copy of this methodology.
Norske Skogindustrier ASA, with headquarters in Oslo, Norway, is among the world’s leading newsprint and magazine producers with production in Europe and Australasia. During 2015 Norske Skog recorded sales of around NOK11.6 billion (approximately EUR1.23 billion).

REGULATORY DISCLOSURES
For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody’s rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider’s credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating.
For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.