OREANDA-NEWS.  Fitch Ratings has assigned Repsol International Finance's (RIF) subordinated notes a final rating of 'BB+'. The notes are guaranteed by Repsol S.A. (BBB/Stable).

The rating of the hybrid capital securities reflects the highly subordinated nature of the notes, considered to have lower recovery prospects in a liquidation or bankruptcy scenario. The equity credit reflects the structural equity-like characteristics of the instruments including subordination, maturity in excess of five years and deferrable interest coupon payments. Equity credit is limited to 50% given the cumulative interest coupon, a feature considered more debt-like in nature.

The notes' rating and assignment of equity credit are based on Fitch's hybrid methodology ("Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis" dated 25 November 2014 on www.fitchratings.com).

KEY RATING DRIVERS FOR THE NOTES
Ratings Reflect Deep Subordination
Fitch has notched the notes' rating down by two notches from Repsol's Long-term Issuer Default Rating of 'BBB'/Stable given their deep subordination and consequently, the lower recovery prospects in a liquidation or bankruptcy scenario relative to the senior obligations of the issuer and guarantor.

Equity Treatment Given Equity-Like Features
The proposed securities qualify for 50% equity credit as they meet Fitch's criteria with regards to deep subordination, remaining effective maturity of at least five years, full discretion to defer coupons for at least five years and limited events of default. These are key equity-like characteristics, affording Repsol greater financial flexibility.

Cumulative Coupon Limits Equity Treatment
The interest coupon deferrals are cumulative, which results in 50% equity treatment and 50% debt treatment of the hybrid notes by Fitch. Despite the 50% equity treatment, we treat coupon payments as 100% interest. The company will be obliged to make a mandatory settlement of deferred interest payments under certain circumstances, including the payment of a dividend. This is a feature similar to debt-like securities and provides the company with reduced financial flexibility.

KEY RATING DRIVERS FOR REPSOL
Stable Outlook
Fitch revised the Outlook on Repsol's IDR to Stable from Positive and affirmed the IDR in December 2014. The Outlook revision followed Repsol's acquisition of all common shares in Talisman for USD8.3bn in cash, which was announced in December 2014. The transaction closed in May 2015.

Focus on Stronger Upstream
We view the acquisition as dramatically improving Repsol's hydrocarbon production profile and mitigating the fall-out from YPF's nationalisation. Post-closing, Repsol's daily hydrocarbon production will be ahead of OMV AG's (A-/Stable, 309mboepd in 2014) and BG Energy Holdings Ltd.'s (BG, A-/RWP, 606mboepd in 2014). Its proved reserves (1P) of 2.4bn barrels of oil equivalent (boe) will rank ahead of OMV's 1.1bn boe, but behind BG's 3.5bn boe, while its proved and probable (2P) reserves are estimated at 3.5bn boe, or about 14 years its combined production. Repsol's upstream will account for nearly 60% of its total capital employed as calculated by the company, up from about 40% before the transaction.

Fitch expects that the combined entity will have a higher degree of flexibility regarding the timing and allocation of capital expenditure. Coupled with strong vertical integration, this should help maintain a healthy balance sheet with funds from operations adjusted net leverage below the 3.0x needed for a 'BBB' rating.

Talisman Performance Risks
Fitch downgraded Talisman in September 2014 to 'BBB-' from 'BBB' due to its weaker production and reserve profiles, relatively high finding, development and acquisition costs, remaining non-core asset sale obstacles and extended development horizon, and possibility for higher leverage metrics without the execution of targeted asset sales.

Integration Strategy Key to Financial Profile
When preparing combined Repsol-Talisman forecasts, we used our most recent Brent oil price deck of USD55 per barrel (bbl) of oil in 2015 raising to USD75/bbl in 2017 and gas prices of USD6 per thousand cubic feet (tcf) in the UK and USD3/tcf in the US. Our base case forecasts are based on the combined pre-acquisition forecasts for Repsol and Talisman, show Repsol's post-closing FFO adjusted net leverage to fluctuate around 3x and FFO fixed charge coverage to around 4x, weaker than those of a median 'BBB' rated oil & gas company. However, we note that Repsol is yet to announce its strategy regarding the integration of Talisman assets, projected capex spending and targeted oil and gas production level, which will likely have a significant impact on leverage ratios.

KEY ASSUMPTIONS
- Brent oil price deck of USD55/bbl in 2015 increasing to USD75/bbl in 2017
- Gas prices of USD6 per thousand cubic feet (tcf) in the UK and USD3/tcf in the US

RATING SENSITIVITIES
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
- FFO adjusted net leverage of 2.5x and FFO fixed charge cover of 8x on a sustained basis.
- Stable FFO margin greater than 10%.
- Capex of no more than 100% operating cash flow.
- Improved downstream performance.

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- FFO adjusted net leverage above 3x and FFO fixed charge cover of 6x and below on a sustained basis.
- Weaker downstream performance than forecast.

LIQUIDITY AND DEBT STRUCTURE
Repsol's cash and deposit balance at end-March 2015 was EUR9.8bn (including EUR1.2bn of deposits with a maturity longer than three months) and covered EUR3.5bn of short-term debt (excluding EUR2.5bn of related-party balances).