Overview -- U.S.-based Roofing Supply Group LLC (RSG) plans to enter into a $290 million seven-year bank term loan B and will issue $200 million of senior unsecured notes due 2020 to refinance existing debt and to partially fund its acquisition by private equity firm Clayton, Dubilier & Rice LLC. -- We are lowering our corporate credit rating to 'B' from 'B+' to reflect the substantial increase in debt balances and leverage, consistent with a "highly leveraged" financial risk profile. -- We are assigning our 'B' issue-level rating to the proposed $290 million senior secured bank term loan B and a 'CCC+' issue-level rating to the $200 million senior unsecured notes due 2020. -- The stable rating outlook reflects our expectation that the company will continue to generate modest positive free cash flow and maintain strong liquidity while reducing total adjusted leverage to about 6x by year end 2012. Rating Action On May 11, 2012, Standard & Poor's Ratings Services lowered its corporate credit rating on Dallas-based Roofing Supply Group LLC (RSG) to 'B' from 'B+'. At the same time, we removed the ratings from CreditWatch negative, where they were placed on April 24, 2012. The outlook is stable. At the same time, we assigned an issue-level rating of 'B' (the same as the corporate credit rating) to RSG's proposed $290 million seven-year senior secured bank term loan B. The recovery rating is '3', indicating our expectation of meaningful (50% to 70%) recovery for lenders in the event of a payment default. We also assigned an issue-level rating of 'CCC+' (two notches below the corporate credit rating) to the proposed $200 million of senior unsecured notes due 2020, with a recovery rating of '6', indicating our expectation of negligible recovery (0% to 10%)to noteholders in the event of a default. These securities are being issued pursuant to Rule 144A of the Securities Act of 1933 without registration rights. The company intends to use proceeds of the proposed notes and term loan, together with cash-on-hand and $210 million of equity from CD&R to fund the acquisition and to repay outstanding borrowings, including its $225 million senior secured notes due 2017. Standard & Poor's affirmed its 'B+' rating on these notes and removed them from CreditWatch. We will withdraw our rating on these notes upon closing of the new transactions. Rationale The downgrade reflects RSG's significant increase in leverage to nearly 6x (adjusted for operating leases) due to the largely debt financed acquisition of the company by private equity firm Clayton, Dubilier & Rice LLC (CD&R). This results in our assessment of a highly leveraged financial profile with leverage measures we would consider inconsistent with the prior rating given our view of the company's "weak" business risk profile. Our business risk assessment incorporates modest but improving operating profitability as a distributor, geographic diversity limited to the U.S., a relatively small size and scale of operations, highly competitive end markets, and exposure to volatile construction cycles and unpredictable weather patterns. Under our baseline scenario, we estimate leverage will likely decline modestly over the next two years, improving to about 5x by the end of 2013. We expect interest coverage of about 3.0x and funds from operations (FFO) to total debt between 10% and 15% over that period. We consider these credit measures to be consistent with the current rating and our view of its highly leveraged financial risk profile. Partially offsetting these risks is our expectation that the company will maintain strong liquidity, due to a very favorable capital structure (minimum debt and capex requirements over the next several years), no financial ratio maintenance requirements, positive cash flow generation and significant availability under its $175 million asset-based revolving credit facility. Our baseline scenario assumes that RSG's roofing supply sales will be flat to up to 1% to 2% in 2012 despite our economist's expectation of 740,000 housing starts in 2012, a 21% increase over 2011. This should help boost demand for RSG's roofing products. Offsetting this increase in sales is the likelihood that in 2012 there will be less demand generated by storm activity in the U.S., which was substantially above average in 2011. However, RSG benefits from relatively stable demand because over 80% of its current sales come from necessary repairs and replacement, which are largely non-discretionary Pro forma for the CD&R transaction and debt refinancing, we expect total debt to approach about $530 million, (adjusted for pensions and operating leases). Based on our assumptions for housing starts and GDP growth (up 2.1%) assumptions, we expect EBITDA in 2012 to total about $85million to $90 million, improving to about $95 million in 2013 as housing markets recover. We expect discretionary cash flow of about $35 million in each of the next two years, which would easily cover annual capex requirements of about $5 million to $7 million per year, with the difference ($25 million to $30 million) to be available for reduction of term loan principal. We are maintaining a positive long-term view of the roofing industry, given an aging housing stock and high percentage of replacement business (currently more than 80% for Roofing Supply Group). We view roof replacement as largely nondiscretionary, with limited ability on the part of consumers to defer replacement over the long term. Weather can also play a significant role, as repairs required after hurricanes and other severe storms often cause an increase in roofing sales, and stable weather patterns can result in less demand. Still, the market is highly fragmented and RSG faces intense competition from both larger, better capitalized companies and smaller local players. Roofing Supply Group is the fourth largest distributor of roofing materials and supplies in the U.S., with 59 branches in 24 states serving a diverse group of roofing contractors, home builders, and retailers. Liquidity Pro forma for the transaction, we expect liquidity to be "strong". We expect the company's proposed $175 million asset-based (ABL) revolving credit facility due 2017 and operating cash flow of about $35 million during 2012 to be the primary sources of liquidity. The company generally borrows in the $20 million to $30 million range during the first half of the year to fund seasonal growth, which usually reverts in the fourth quarter of the calendar year through cash collections. Cash balances are generally minimal until the fourth quarter. Our view of the company's liquidity profile takes into consideration the following factors: -- We expect that liquidity sources (including cash, discretionary cash flow, and availability under its $175 million ABL revolving credit facility) will exceed uses by 1.5x over the next 12 months and 1x over the next 24 months. -- We expect that liquidity sources will continue to exceed uses, even if EBITDA were to decline by 30%. -- Given the company will not be subject to financial ratio maintenance covenants, we would not view liquidity as impaired following a 30% drop in EBITDA. The company's liquidity also benefits from the proposed capital structure with only a fixed-charge requirement effective when availability under the ABL facility falls below minimum levels. Also, the company will have no debt maturities until 2017 when its proposed ABL matures. Required amortization under the term loan will total less than $3 million per year. CAPEX requirements are very modest at $5 million to $7 million per year. We do not anticipate significant acquisition activity or any dividend return to owners in the next 1-2 years. Recovery analysis For the complete recovery analysis, see Standard & Poor's recovery report on Roofing Supply Group LLC to be published on RatingsDirect after this report. Outlook The outlook is stable. We expect end-market demand for RSG's roofing products to be relatively flat over the next 12 months because demand caused by the expected improvement in housing starts will be offset by less storm activity compared with 2011. As a result, we expect credit metrics to remain in line with a highly leveraged financial risk profile, with adjusted leverage improving to about 5x by the end of 2013. In addition, we believe liquidity, in terms of cash, availability under the revolving credit facility, and cash flow from operations will be more than sufficient to meet the company's seasonal working capital needs and other obligations, including $5 million to $7 million of estimated capital expenditures and about $30 million of annual interest expense. In our view, we could consider raising the ratings if RSG's operating prospects during the next several quarters exceed our current expectation due to stronger-than-expected housing starts and higher roof replacement volumes because of increased consumer confidence. Under this scenario, the company's adjusted leverage could improve to 5x or below on a sustained basis. Although we think a downgrade is unlikely the near term, we could take a negative rating action during this period if raw material cost volatility or intense price competition brings operating margins to below 5%, causing the company's credit measures to deteriorate below expected levels, or if the company pursued an aggressive acquisition or dividend policy. Specifically, we could lower the ratings if leverage exceeded 7x. Related Criteria And Research -- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Business Risk/Financial Risk Matrix Expanded, May 27, 2009 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Downgraded; Off CreditWatch; Outlook Stable To From Roofing Supply Group LLC Corporate Credit Rating B/Stable/-- B+/Watch Neg/-- New Ratings Roofing Supply Group LLC Senior Secured US$290 mil fltg rate sr secd term B due 2019 B Recovery Rating 3 Senior Unsecured US$200 mil sr nts due 2020 CCC+ Recovery Rating 6 Ratings Affirmed; Off CreditWatch Roofing Supply Group LLC Roofing Supply Finance Inc. Senior Secured B+ B+/Watch Neg Recovery Rating 4 4 Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. 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