DBRS Downgrades Catalyst Paper Issuer Rating to CCC (high), Trends to Negative

DBRS has today downgraded the Issuer Rating of Catalyst Paper Corporation (Catalyst or the Company) to CCC (high) from B (low). DBRS has also assigned a new rating of B (high) to the Company’s Senior Secured Debt and has confirmed Catalyst’s Senior Debt at CCC. In addition, a recovery rating of RR1 has been assigned to the Senior Secured Debt, which reflects an estimated 90% to 100% recovery of principal amounts of the debentures under a hypothetical default scenario and a recovery rating of RR5 to the Senior Notes, which reflects an estimated 10% to 30% recovery of principal amounts. The RR1 recovery rating corresponds to the Senior Secured Debt rating of B (high) and the RR5 recovery rating corresponds to the CCC rating for the Senior Debt. All the ratings have Negative trends. Concurrently, DBRS has also downgraded the tender notes of Catalyst to D following the execution of its notes exchange offer. The default status for the exchanged and now extinguished debt reflects DBRS’s view that certain bondholders, which consented to the exchange offer, were paid out less than face value, which, as discussed in DBRS’s press release dated November 26, 2009, is considered a default by DBRS policy. With these rating actions, the Company is removed from Under Review with Negative Implications where it was placed on November 26, 2009.

The downgrade of the Issuer Rating reflects continuing deterioration at Catalyst since our last downgrade action in November 2009. DBRS had expected the Company to be able to stabilize operating results in light of improving economic conditions. However, EBITDA in Q4 2009 was just modestly positive and was the lowest quarterly result in 2009. All the debt coverage ratios have also declined. The Company had not benefited from improving economic conditions as expected. The prices and demand for directory paper actually declined, and the prices for coated and uncoated paper were also lowered due to increased supply. Additionally, a strengthened Canadian dollar has also limited the benefits of the Company’s cost reduction efforts. The Negative trend reflects that the Company continues to face significant headwinds to turn its operations around in the near term. Industry conditions are expected to remain challenging. Although the general economy in North America appears to have turned the corner, persistent high unemployment rates seem to have slowed the pace of a potential recovery, impacting the demand for print advertising. Increased competition from digital media, a worrying structural change in the paper industry, further negatively impacts the supply-demand balance. The near-term outlook for the industry remains weak. Conditions of excess supply across all markets in which the Company operates are expected to continue, causing the operating rates to remain low. Additionally, with most of its mills based in Canada, the ongoing strength of the Canadian dollar would add to margin pressure and depress the Company’s profitability.

Catalyst has improved its financial flexibility by executing a private exchange, swapping most of its senior notes maturing in June 15, 2011 with new secured senior notes maturing in December 15, 2016. This has alleviated a near term refinancing risk allowing the Company more time and financial flexibility to weather the current weak market conditions and engineer a sustainable recovery. DBRS notes that liquidity at the Company remains tight despite having about $157 million (cash and available credit facility) available at the end of December 2009. Unless the demand shows a meaningful and sustainable recovery, ongoing cash burn due to capacity curtailments required to keep pace with current weak demand could drain the Company’s available liquidity. The Company also faces a number of cash payments in the next 15 months, such as severance to Elk Falls and Crofton mill employees and the maturing untendered 8 5/8% Senior Notes in June 15, 2011 (about US$35.5 million) which further add pressure to its liquidity position.

Pursuant to its rating methodology for leveraged finance, DBRS has created a default scenario for Catalyst in order to analyze when and under what circumstances a default could hypothetically occur and the potential recovery of the Company’s debt in the event of such default The scenario assumes that the United States economy fails to recover and falls into a recession again later in 2010. This would lead to continued deterioration in the demand for pulp and paper. In addition, it is assumed that the Canadian dollar remains high relative to the U.S. dollar in 2010 and 2011. Under this scenario, the Company would exhaust its liquidity in late 2011

DBRS has determined Catalyst’s estimated value at default using an EBITDA multiple valuation approach, consistent with a view that default would likely result in the restructuring and/or recapitalization of the assets with value as a going concern versus the sale of its individual assets. EBITDA multiples utilized are applied to cyclically normalized EBITDA at default as opposed to the actual low EBITDA values expected at the time of default, reflecting the forward-looking nature of the valuation.

The valuation considers the issuer and the specific debt instruments, allocating value proceeds accordingly – that is, debt recovery in the ABL Facility first before any residual proceeds can be used to recover the Senior Secured Debt and then the Senior Debt. Capital leases are assumed to rank ahead of unsecured debt.

DBRS has forecast the economic value of the components of the enterprise at approximately $550 million using a 4.0 times (x) multiple of normalized EBITDA for Catalyst.

Based on the default scenario above, the newly issued Senior Secured Debt recovery is estimated between 90% to 100%, and hence a recovery rating of RR1 which results in three notches above the Issuer Rating to a B (high) rating. The Senior Debt, which ranks below the Senior Secured Debt, has a recovery estimated between 10% and 30% which results in one notch below the Issuer Rating to a CCC rating.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The applicable methodologies are Rating the Forest Products Industry and Rating Methodology for Leveraged Finance, which can be found on our website under Methodologies.

This is a Corporate rating.