Fitch Ratings has affirmed Chesapeake Energy Corporation's (Chesapeake;
NYSE: CHK) Long-term Issuer Default Rating (IDR) at 'BB-'. The Rating
Outlook has been revised to Negative.
Fitch expects to rate the company's planned second lien notes issuance
'BB'/RR2. Chesapeake announced the commencement of private offers of up
to $1.5 billion in new 8% senior secured second lien notes due 2022 in
exchange for certain outstanding senior unsecured notes. The early and
late exchange offers expire on Dec. 15 and Dec. 30, 2015, respectively.
Fitch believes that the exchange offer will help to reduce balance sheet
debt and alleviate medium-term liquidity concerns by addressing the
company's current maturities profile. Fitch also recognizes that,
subject to the senior unsecured notes exchanged, the exchange could
increase or decrease cash interest payments.
The Negative Outlook reflects heightened asset sale execution risk, as
well as the potential for further deterioration of the free cash flow
(FCF) profile. Fitch believes that the announced private exchange offer
signals management's unwillingness or inability to sell assets in the
current stressed hydrocarbon pricing environment to help address
forecasted FCF shortfalls and debt maturities. While the company
currently maintains adequate liquidity, without support from asset sales
over the medium-term, financial flexibility could be reduced to levels
inconsistent with a 'BB-' rating.
Additionally, as a result of the exchange offer, Fitch has placed
Chesapeake's senior unsecured notes on Rating Watch Negative. This
reflects management's intent to further subordinate the senior unsecured
notes through the announced exchange offering, which reduces unsecured
recovery prospects. The Rating Watch Negative also recognizes that the
company may pursue more secured for unsecured exchange offerings over
the next several months. Fitch intends on resolving the Rating Watch
Negative upon completion of the announced exchange and as the potential
for and effects of further exchanges becomes clearer.
Fitch does not view the announced exchange as a distressed debt
exchange. The exchange acceptance priority and sliding conversion scale
are not anticipated to result in a material reduction in terms. Further,
Fitch believes that the exchange is largely opportunistic and not
necessary to avoid a near-term bankruptcy or payment default.
Approximately $11.3 billion and $3.1 billion in balance sheet debt and
convertible preferred stock, respectively, are affected by today's
rating action. A full list of rating actions follows at the end of this
release.
KEY RATING DRIVERS
Chesapeake's ratings reflect its considerable size with an increasingly
liquids-focused production profile and proved reserves (1p) base, solid
reserve replacement history, adequate near-term liquidity position, and
strong operational execution with ongoing improvements leading to
competitive production and cost profiles. These considerations are
offset by the company's levered capital structure, continued exposure to
legacy drilling, purchase, and overriding royalty interest obligations,
natural gas weighted profile that results in lower netbacks per barrel
of oil equivalent (boe) relative to liquid peers, and weaker realized
natural gas prices after differentials are incorporated. Fitch
recognizes, however, that Chesapeake has made significant progress
towards its financial and operational deleveraging efforts since 2013.
The company reported year-end 2014 net proved reserves of nearly 2.5
billion boe and production of 707 thousand boe per day (mboepd; 29%
liquids). This resulted in a year-end reserve life of just under 10
years. Third quarter 2015 production was 667 mboepd (28% liquids) with
declining quarterly trends mainly related to reduced rig activity. The
Fitch-calculated one-year organic reserve replacement rate was about
154% for year-end 2014 with an associated finding and development (F&D)
cost of approximately $10.15 per boe. Fitch-calculated third quarter
hedged and unhedged cash netbacks were $7.11/boe and $2.29/boe,
respectively. Unhedged cash netbacks have dropped 87% since year end
2014 mainly due to weakness in market prices and unfavourable
differentials.
The increase in latest-12-month (LTM) balance sheet debt/EBITDA to
approximately 3.9x, as of Sept. 30, 2015, compared to 2.6x at year end
2014 demonstrates the impact of lower hedged price realizations.
Chesapeake's debt/1p reserves and debt/flowing barrel have remained
relatively steady at approximately $5.37/boe, and $19,900, respectively.
Fitch's base case, excluding the potential reduction in gross debt
post-exchange, forecasts debt/EBITDA of approximately 5.4x and 9.7x in
2015 and 2016, respectively.
KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for Chesapeake include:
--WTI oil price that trends up from $50/barrel in 2015 to a long-term
price of $70/barrel;
--Henry Hub gas that trends up from $2.75/mcf in 2015 to a long-term
price of $3.75/mcf;
--Production of 671 mboepd in 2015, generally consistent with guidance,
followed by price- and cash flow-linked production growth;
--Liquids mix declines to 28% in 2015 due to lower drilling activity,
particularly in the liquids-rich Eagle Ford basin, with activity focused
in operationally committed and shorter-cycle gas-oriented plays
near-term;
--Differentials are projected to exhibit improving trends over the
medium term due to some Marcellus basis tightening and gathering cost
relief;
--Capital spending is forecast to be $3.25 billion in 2015, consistent
with guidance, followed by a more balanced capex profile thereafter;
--Non-core asset sales of $250 million assumed to be completed in 2016;
--No increase in long-term balance sheet debt assumed.
RATING SENSITIVITIES
Positive: Future developments that may, individually or collectively,
lead to a positive rating action include:
--Maintenance of size, scale, and diversification of Chesapeake's
operations with some combination of the following metrics;
--Mid-cycle balance sheet debt/EBITDA under 3.5x on a sustained basis;
--Balance sheet debt/flowing barrel under $25,000 - $30,000 and/or
debt/1p below $7.00 - $7.50/boe on a sustained basis;
--Continued progress in materially reducing adjusted debt balances and
simplifying the capital structure;
--Improvements in realized oil & gas differentials.
Negative: Future developments that may, individually or collectively,
lead to a negative rating action include:
--Mid-cycle balance sheet debt/EBITDA above 4.5x - 5.0x on a sustained
basis;
--Balance sheet debt/flowing barrel of $35,000 - $40,000 and/or debt/1p
above $8.00-$8.50/boe on a sustained basis;
--An unwillingness or inability to execute asset sales, if necessary, to
help address forecasted FCF shortfalls and debt maturities;
--A persistently weak oil & gas pricing environment that impairs the
longer-term value of Chesapeake's reserve base;
--Acquisitions and/or shareholder-friendly actions inconsistent with the
expected cash flow and leverage profile.
ADEQUATE NEAR-TERM LIQUIDITY POSITION
Proforma cash & equivalents, as of Sept. 30, 2015, were nearly $1.4
billion, considering the Nov. 2015 repayment of $394 million in
contingent convertible senior notes. Additional liquidity is provided by
the company's recently amended
$4 billion senior secured credit facility due December 2019. There were
no outstanding borrowings under the facility, as of Sept. 30, 2015, with
$12 million of the facility capacity used for various letters of credit.
Fitch's base case forecasts the company will end 2015 with approximately
$1.1 billion in cash & equivalents assuming the $200 - $300 million in
planned non-core asset sales are completed in 2016.
ESCALATING MATURITIES PROFILE
The company has an escalating maturities profile with $500 million, $2.2
billion, $1.0 billion, and $1.5 billion due in 2016 - 2019. These
amounts include the $1.2 billion and $347 million in contingent
convertible senior notes with holders' demand repurchase dates in May
2017 and December 2018, respectively. If oil & gas prices remain
depressed in the medium-term, Fitch believes it is likely that the
contingent convertible senior notes holders will exercise their demand
rights for a cash repurchase given the five-year demand repurchase date
schedule and considerable spread between the current stock price and
conversion threshold.
Fitch recognizes that the announced exchange offering will help to
address the company's escalating maturities profile. The exchange grants
priority and better exchange consideration terms to the near-term
maturities.
MODIFIED FINANCIAL COVENANT PACKAGE
Financial covenants, as defined in the recently amended credit facility
agreement, consist of a maximum net debt-to-book capitalization ratio of
65% (38% as of Sept. 30, 2015), senior secured leverage ratio of 3.5x
through 2017 and 3.0x thereafter (no secured debt is currently
outstanding), and an interest coverage ratio of 1.1x through Q1 2017
followed by periodic increases to 1.25x by the end of 2017 (4.7x). Other
customary covenants across debt instruments restrict the ability to
incur additional liens, make restricted payments, and merge,
consolidate, or sell assets, as well as change in control provisions.
The company also has the ability to incur up to $2 billion of junior
lien debt. Any junior lien issuances could reduce revolver availability
after April 15, 2016 (the first borrowing base redetermination date).
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings:
Chesapeake Energy Corporation
--Long-term IDR at 'BB-';
--Senior secured bank facility at 'BB+'/RR1;
--Senior unsecured notes at 'BB-'/RR4;
--Convertible preferred stock at 'B'/RR6.
The Rating Outlook was revised to Negative from Stable. Additionally,
the senior unsecured notes were placed on Rating Watch Negative.
Fitch also expects to rate the senior secured second lien notes as
follows:
--Senior secured second lien notes 'BB'/RR2.
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
Recovery Ratings and Notching Criteria for Non-Financial Corporate
Issuers (pub. 12 Jun 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=867275
Additional Disclosures
Dodd-Frank Rating Information Disclosure Form
https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=995974
Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=995974
Endorsement Policy
https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31
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