Fitch Revises Rating Watch on Samarco to Negative

CHICAGO--(BUSINESS WIRE)-- Fitch Ratings has revised the Rating Watch on Samarco Mineracao S.A.'s (Samarco's) ratings to Negative from Evolving. A full list of rating actions follows at the end of this release.

Samarco benefits from its ownership under two industry leaders, Vale S.A. (Vale; 'BBB'/Outlook Negative) and BHP Billiton Limited/Plc (BHPB; 'A+'/Outlook Negative), with each company owning 50% of Samarco. Fitch believes Samarco's two strong shareholders will continue to support Samarco through the challenges of the next two years in order to resume normalized operations following the announcement of the settlement with the Brazilian authorities.

KEY RATING DRIVERS

Landmark Agreement Reached:

The outcome of discussions between Samarco, Vale and BHPB with the Brazilian authorities has been finalized. The agreement covers remediation, mitigation and compensation for the tailings dam accident, and is subject to final court approval. Fitch considers the final agreement terms as being manageable for the three mining companies, as discussed in Fitch's special report 'Samarco - Binary Outcome' (February 2016), and assumes Samarco's operations to resume in late 2016.

Ratings Continue to Reflect Shareholder Support:

Fitch has revised the Rating Watch to Negative from Evolving following the announcement. The Rating Watch Negative reflects the pending final approval by the courts and the uncertainty regarding the length of time until Samarco is able to resume operations. Vale and BHPB have guaranteed the funding for the foundation to be created as part of the agreement and are expected to continue supporting Samarco until it resumes normalized operations.

Rating Watch Negative Resolution:

The Rating Watch Negative provides Samarco with approximately three months to regain the necessary operating licenses required to restart operations. Failure to do so may result in a multi-notch downgrade, notwithstanding tangible shareholder intervention in the form of a capital contribution. Should the licences be reinstated within the three month timeframe, Fitch expects operations to resume at the beginning of the fourth quarter 2016. If operations do not begin and are not close to starting within this timeframe, significant further delay may increase Samarco's risk of bankruptcy, also resulting in a multi-notch downgrade notwithstanding significant shareholder support. The ratings continue to factor in a two-notch uplift from Samarco's standalone rating of 'B' reflecting Fitch's view of ongoing shareholder support. Should tangible support not materialize to the extent Fitch expects, the two-notch differential may be reduced to one.

Limited Cashflow Impact on Shareholders:

Fitch's cash flow assumptions indicate limited impact on Vale and BHPB. In the event Samarco is unable to comply with its payment commitments to the foundation, the amount payable each year is very manageable to the company's shareholders and the shortfall required will be divided between them equally. Fitch resolved the Rating Watch Negative on Vale's international ratings to 'BBB'/Outlook Negative following the announcement and reflecting the Outlook on Brazil's sovereign rating.

Near-Term Deal Payments:

The three mining companies have agreed that Samarco will pay BRL2 billion in 2016. This amount will include money spent on the related clean-up, remediation and compensation costs paid by Samarco to date. Fitch assumes an additional USD375 million to be funded by the company in 2016 to meet this total amount net of spending to date. Cash of approximately USD230 million frozen by the courts is also expected to be released. Fitch's assumes Samarco's standalone cash balance to be approximately USD10 million at year-end 2016 and includes cash inflows related to estimated accounts receivables, tax refunds, and financial earnings.

Long-Term Deal Payments:

A maximum cap of BRL1.2 billion per year in 2017 and 2018 has been established with BRL240 million within these amounts each year set as a compensation limit. The total amount of the remediation and compensation agreed is BRL4.4 billion spanning 2016-2018. A sewage and water program has also been established within these annual limits to pay BRL50 million in 2016, BRL200 million in 2017 and BRL250 million in 2018. From 2019-2021 a range of BRL800 million to BRL1.6 billion has been set as annual contributions to the foundation based on the amount dictated by requirements. This amount is not an upfront figure - it will be the cap at which Samarco will meet any claims agreed by the foundation and will only be spent as required. The terms provide for a period of 15 years with 2022 to 2030 establishing a compensation limit of BRL240 million a year. The total maximum amount over the entire 15 years could be as high as BRL11.4 billion or as low as BRL9 billion under the assumption that compensation payments continue to be required post 2020.

Foundation to Disburse Funds:

A foundation will be established within 120 days of the agreement by the government and the three mining companies to manage the funds paid into it. The foundation will address future claims and decide appropriate actions to ensure the Doce River Basin is environmentally recovered to pre-accident levels and affected parties appropriately compensated and remediated. The foundation committee will be comprised by two representatives from Samarco, two from Vale, two from BHPB and one from the government.

Covenant Waivers Expected:

Samarco will breach its net debt/EBITDA covenant of 4.0x and covenant relating to the flow of export receivables from pre-export loan agreements during the next covenant test date in first-quarter 2016. Fitch expects waivers to be received for these covenants, with the relevant banks being incentivized by the settlement. The framework provided by this expected agreement should pave the way for a resumption of Samarco's operations and lead to the relatively swift restoration of its operating licenses in Minas Gerais. The possibility of Samarco resuming its operations during 2016 has increased in likelihood since the initial fall-out from the accident.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for Samarco include:

--Resumption of operations in late 2016.

--No income taxes due to combination of losses and deferrals during the period.

--No business interruption insurance proceeds due to ongoing process.

--Fitch's mid-cycle price assumptions for iron ore (62% Fe CFR China reference) at USD45/tonne in 2016 and 2017, USD50/tonne in 2018.

--Iron ore pellet sale volumes of approximately 5 million tonnes in 2016, 20 million tonnes in 2017 and 2018, normalized production of approximately 30 million tonnes achieved in 2019.

--Funding requirements to be met through debt financing and/or combination of capital injection or shareholder loans.

RATING SENSITIVITIES

Samarco's ratings could be downgraded should Fitch observe deterioration in Vale's and BHPB's commitment to support Samarco during the challenges over the next few years as the company rebuilds its operations. A downgrade could also occur if the company takes significantly longer than anticipated to resume operations and liquidity is pressured notwithstanding shareholder support. A significant erosion in credit quality of the shareholders and/or a financial loss related to a sizeable criminal case, or other litigation not covered within the settlement, could also lead to negative action. The absence of public federal and state prosecutors' as signatories to the agreement is a concern that could lead to further criminal legal claims

An upgrade is not envisaged during the next few years as the company returns to normalized operations at full installed capacity over an estimated two year period.

LIQUIDITY

Fitch's assumes Samarco's standalone cash balance to be approximately USD10 million at year-end 2016 and includes cash inflows related to estimated accounts receivables, financial earnings and tax refunds. Access to new financing is also expected to be possible once the company resumes operations, possibly by late 2016. Fitch continues to factor-in financial assistance from shareholders, in the event it is required.

FULL LIST OF RATING ACTIONS

Fitch has revised the Rating Watch on Samarco's ratings as follows:

--Local currency long-term IDR 'BB-', Rating Watch revised to Negative from Evolving;

--Foreign currency long-term IDR 'BB-', Rating Watch revised to Negative from Evolving;

--National long-term rating 'A(bra)', Rating Watch revised to Negative from Evolving;

--Senior unsecured debt rating 'BB-', Rating Watch revised to Negative from Evolving.

Date of Relevant Rating Committee: March 3, 2016.

Additional information is available on www.fitchratings.com.

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362

Additional Disclosures

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1000505

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Fitch Ratings
Primary Analyst
Jay Djemal
Director
+1-312-368-3134
Fitch Ratings, Inc.
70 West Madison St
Chicago, IL, 60602
or
Secondary Analyst
Debora Jalles
Director
+1-312-606-2338
or
Committee Chairperson
Daniel R. Kastholm, CFA
Managing Director
+1-312-368-2070
or
Media Relations:
Elizabeth Fogerty, +1-212-908-0526
[email protected]

Source: Fitch Ratings

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