OREANDA-NEWS. Fitch Ratings expects to rate Chesapeake Energy's (NYSE: CHK), recently announced private placement of $1.1 billion aggregate principal amount of 5.5% convertible senior unsecured notes due 2026 'B-'(EXP)/'RR4'. The notes are convertible into cash, CHK common stock, or a combination of both, upon certain specified circumstances at Chesapeake's election. The 5.5% notes mature on Sept. 15, 2026 and can't be redeemed by Chesapeake prior to Sept. 15, 2019.

Chesapeake may redeem the notes at its option on or after Sept. 15, 2019 subject to specified parameters in the private placement memorandum. The company intends to use the proceeds of the offering for general corporate purposes, including terming out its maturities as they come due, and paying down outstanding borrowings under the revolver. The notes will be pari-passu with existing senior unsecured debt.

KEY RATING DRIVERS

Chesapeake's ratings reflect its considerable size with the potential for more liquids-focused production, substantial asset base, and strong operational execution and flexibility with ongoing improvements leading to competitive production and cost profiles. Fitch views the company's focus on completion activities, instead of drilling, in 2016 positively. This more closely aligns current capital spending with production and, as a consequence, with cash flows.

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 in its financial and operational deleveraging efforts since 2013, including the recently announced Barnett Shale conveyance and Mid-Continent renegotiation that management expects to improve midstream gathering, processing, and transportation expenses, albeit at an upfront cash cost of approximately $400 million.

The company reported year-end 2015 net proved reserves of over 1.5 billion boe, which is a year-over-year reduction of approximately 39% mainly due to price-related reserve revisions. Production continues to show activity - and asset sale-related declines at approximately 658 thousand boe per day (mboepd; 25% liquids) resulting in a quarter-over-quarter decline of 2%.

Fitch estimates Chesapeake's balance sheet debt/EBITDA to be approximately 7.2x for the latest 12 months ended June 30, 2016, compared to 3.9x and 2.6x for the years ended Dec. 31, 2015 and 2014, respectively. Fitch calculated debt/flowing barrel metrics were over $19,200 as of June 30, 2016. Fitch's base case currently forecasts debt/EBITDA of approximately 8.5x in 2016. This assumes the completion of an additional $1 billion (total $2 billion for 2016) in asset sales limiting the need for credit facility borrowings. Upstream leverage metrics are projected to remain relatively steady through 2016.

KEY ASSUMPTIONS

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

--Base case WTI oil price that trends up from $42/barrel in 2016 to a long-term price of $65/barrel;

--Base case Henry Hub gas that trends up from $2.35/mcf in 2016 to a long-term price of $3.25/mcf;

--Production of approximately 625 mboepd and 547 mboepd in 2016 and 2017, respectively;

--Liquids mix declines to 25% in 2016 followed by an improvement to 27% in 2017;

--Differentials are projected to exhibit improving trends over the near - and medium-term due to recent gathering, processing, and transportation cost relief and some Marcellus basis tightening;

--Capital spending is forecast to be $1.25 billion and $2 billion in 2016 and 2017, respectively;

--Asset sales of $2 billion assumed to be completed in 2016 followed by a robust level of asset sales over the next couple of years;

--Continued suspension of preferred and common dividends medium-term;

--No increase in long-term balance sheet debt assumed.

RATING SENSITIVITIES

Positive: No upgrades are currently contemplated given weakening credit metrics associated with low oil & gas prices. Future developments that may, individually or collectively, lead to a positive rating action include:

For an upgrade to 'B':

Maintenance of size, scale, and diversification of Chesapeake's operations with some combination of the following metrics:

--Mid-cycle balance sheet debt/EBITDA under 6.0x - 7.0x on a sustained basis;

--Balance sheet debt/flowing barrel under $40,000 - $45,000 on a sustained basis;

--Continued progress in materially reducing adjusted debt balances and simplifying the capital structure;

--Improvements in realized oil & gas differentials.

To resolve the Negative Outlook at 'B-':

--Asset sale execution that alleviates the company's near-term reliance on its revolving credit facility to help fund FCF deficits;

--Improving oil & gas price environment and sufficient liquidity to help address escalating maturities profile;

--Mid-cycle balance sheet debt/EBITDA under 7.0x-8.0x on a sustained basis;

--Balance sheet debt/flowing barrel under $45,000 - $50,000 on a sustained basis.

Negative: Future developments that may, individually or collectively, lead to a negative rating action include:

--Mid-cycle balance sheet debt/EBITDA above 8.0x on a sustained basis;

--Balance sheet debt/flowing barrel over $55,000 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.

LIQUIDITY

Cash & equivalents, as of June 30, 2016, were approximately $4 million. Additional liquidity is provided by the company's amended $4 billion senior secured credit facility ($3.1 billion available as of June 30, 2016) due December 2019. The next borrowing base redetermination date was rescheduled and postponed until June 2017.

Chesapeake, as of Aug. 4, 2016, has hedged about 75% of its projected oil and natural gas production for the remainder of 2016, or approximately 12.1 mmboe and 373 Bcf, at approximately $46.60/barrel and $2.77/mcf, respectively. The company has also been adding 2017 oil and natural gas hedges for approximately 7.7 mmboe and 290 Bcf at approximately $47.79/barrel and $3/mcf, respectively.

EVOLVING MATURITIES PROFILE

The company has an escalating maturities profile with approximately $1.4 billion, $850 million, $1 billion, and $1.1 billion due between 2017 and 2020. These amounts include the approximately $730 million and $315 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. The recently announced debt tenders should help to further improve the company's near-term maturity profile.

SUSPENDED AND MODIFIED MAINTENANCE COVENANTS

Financial covenants, as defined in the amended credit facility agreement, have been suspended until September 2017 with the exception of the interest coverage ratio. The coverage ratio was reduced to 0.65x through March 2017, increasing to 0.7x through June 2017, and reverting to 1.2x in September 2017 and to 1.25x thereafter. During the covenant suspension period, Chesapeake has agreed to maintain a minimum liquidity amount of $500 million that increases to $750 million if collateral coverage falls below 1.1x as of Dec. 31, 2016. 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 amended, under the terms of the credit agreement, its ability to incur secured debt to up to $2.5 billion.

FULL LIST OF RATING ACTIONS

Chesapeake Energy Corporation:

--Senior unsecured notes 'B-'(EXP)/'RR4'.

Fitch currently rates Chesapeake Energy Corporation as follows:

--Long-Term IDR 'B-';

--Senior secured bank facility 'BB-'/'RR1';

--Senior secured term loan 'BB-'/'RR1';

--Senior secured second lien notes 'B+'/'RR2';

--Senior unsecured notes 'B-'/RR4'

--Convertible preferred stock 'CCC'/'RR6'.

The Rating Outlook remains Negative.