OREANDA-NEWS. Fitch Ratings has downgraded Offshore Drilling Holding, S.A.'s (ODH) foreign and local currency Issuer Default Ratings (IDRs) to 'B+' from 'BB-' and placed the ratings on Negative Rating Watch. Fitch has also downgraded the company's USD950 million of senior secured notes due 2020 to 'BB-'from 'BB'.

Fitch is assigning an 'RR3' Recovery Rating to the international notes. The 'RR3' for the outstanding company's senior secured notes reflects a good expected recovery given default.

KEY RATING DRIVERS

Fitch's rating actions reflect the heightened exposure of the company to contract roll-over risk and pricing risk as a result of current depressed market conditions. The Negative Watch reflects the possibility that a prolonged oil price drop will compound the effects of the offshore rig oversupply cycle, resulting in weaker than previously expected market dayrates. If the amendments to the contracts contemplating a minimum dayrate for future extensions are not executed, it would expose the company to re-chartering the rigs based on current declining day rates in a highly competitive environment, resulting in a weaker leverage profile. The Negative Watch also considers Fitch's concerns regarding the extension of the contract for Centenario beyond December 2015. While the company has indicated that it has reached an agreement with Petroleos Mexicanos SA (Pemex, IDR 'BBB') for the extension of the contract until December 2016, the amendment has not been executed, adding to the risk that cashflows to the holding company may be disrupted until the asset is re-contracted.

Ultimately ODH's ratings are supported by the company's solid commercial relationship with Pemex, the company's moderately high leverage, and partial structural subordination. The company's expansion plan is considered aggressive..

SOLID COMMERCIAL RELATIONSHIP WITH STRONG OFFTAKER
ODH's ratings reflect the strong commercial relationship of the company and its shareholder, Grupo R, with Pemex. ODH and Grupo R, a privately held conglomerate, provide offshore drilling services, as well as other energy-related maritime services, to Pemex, its only customer. ODH currently owns three ultra-deep-water (UDW) sixth-generation dynamic positioning semisubmersible drilling rigs, which are contracted with Pemex at dayrates ranging from USD365,000 to USD489,000.

OIL PRICE DROP PRESSURES OFFSHORE MARKET FURTHER
Offshore drillers have been facing softening market conditions due to lower demand and a significant newbuild backlog. The over 60% drop in oil prices has compounded the effects of the oversupply cycle resulting in a decline in market dayrates of roughly 50% from pre-cycle levels and it has heightened pressure on utilization rates, decreasing to approximately 74%-80% for UDW assets worldwide. Fitch continues to believe that medium-term demand will rebound and absorb the newer high-quality assets which operate more efficiently. Trough-to-previous peak rig response in the most recent bear markets shows that the pace of a rig count recovery depends on the speed and intensity of the price recovery. Strong players in their local markets with state of the art assets may have competitive advantages over their international peers.

CONTRACT ROLL-OVER RISK
The company is exposed to contract renewal risk given that the three UDW drilling rigs have contracts that expire before the maturity of the notes. The contract for Centenario has recently been extended until December 2015 at a dayrate of $365,000. The company has also reached an agreement with Pemex to further extend the contracts for both rigs until December 2016 in return for lowering the current day rate for Bicentenario to $365,000. These agreements also consider the option to include a minimum day rate for the contracts of $365,000 for future extensions. These amendments are yet to be signed by Pemex.

Current depressed market conditions have affected UDW rig utilization rates; a sustained oversupply of assets worldwide may affect the company's ability to re-contract the assets out of Mexico. However, the performance and specifications of the rigs and strong relationship of the company with Pemex make ODH a strong player in the Mexican drilling market. Pemex may favor continuity and fostering relationships with its existing drilling providers under the right conditions, partially mitigating the re-chartering risk. The rating incorporates Fitch's expectation that Pemex will re-contract these drilling rigs shortly before the contracts expire.

EXPOSURE TO MARKET DAY RATES PARTIALLY MITIGATED
While the provision to set a minimum day rate of $365 thousand expected to be included in the contracts limits the impact of a further deterioration of the offshore rig market, the amendments have yet to be signed. Fitch's ratings assume day rates will recover in the medium term and a provision will be included in the contracts limiting the downside effect of deteriorating day rates. If the amendments are not formalized and the dayrates are allowed to float below the current depressed market day rates, it may have an impact on the financial profile of the company. The company's cash flow stability and predictability will benefit if contracts were to be renewed at fixed day rates for longer periods of time.

PARTIAL STRUCTURAL SUBORDINATION
ODH's senior secured notes are guaranteed by certain restricted subsidiaries, including the unencumbered subsidiaries that own the Centenario and Bicentenario drilling rigs. The notes benefit from a 12-month interest reserve account and are currently structurally subordinated to a project-finance bank loan of approximately USD363 million, related to the financing of La Muralla IV. This bank debt has certain cash sweep provisions restricting cash flow distributions to ODH. The bank loan amortizes through 2018 and once it is repaid, La Muralla IV will become a co-guarantor for the notes.

MODERATELY HIGH LEVERAGE
ODH's leverage ratio for the last 12 months (LTM) ended March 30, 2015 improved slightly to 3.72x from 3.87x as of the LTM March 2014. ODH's EBITDA as of LTM ended March 2015 amounted to approximately USD354 million. Going forward, total leverage is expected to range between 4x and 4.5x, with the exception of years when the company adds financial debt to fund acquisitions without reporting a full year of operational revenues for the new assets. ODH's total debt of USD1.31 billion as of June 30, 2015 was composed of USD950 million rated bonds due 2020 and the balance relates to an amortizable bank loan guaranteed by La Muralla IV. In the medium term ODH expects to initially finance the shallow-water drilling rigs (jack-ups) on a non-recourse basis through an unrestricted subsidiary, and once the rigs are contracted, the company may issue additional debt under the same conditions as the existing bonds, while the subsidiary could be redefined as a restricted subsidiary.

AGRRESSIVE SPECULATIVE GROWTH STRATEGY
ODH's ratings incorporate the expectation the company would continue to add offshore drilling equipment without increasing its leverage on a sustained basis. Currently the company has construction orders for five jack-ups, for which it is yet to sign contracts with Pemex. Two of them, Cantarel I and Cantarel II, are expected to be delivered by the end of August and will leave the shipyard for Mexico by the second half of September. The company expects to sign contracts with Pemex for these two units shortly. Although the company has operated this way in the past, current market conditions exacerbate the risk of not getting contracts for the rigs, adding uncertainty to cash flow generation and high carrying cost should Pemex not contract the rigs and ODH has to find alternative markets for the equipment.

RATING SENSITIVITIES
Positive: Future developments that may, individually or collectively, lead to a positive rating action include:
-- Through-the-cycle consolidated debt/EBITDA decreases below 3.5x on a sustained basis;
-- The company contracts all its drilling equipment with very limited to none out-clauses and with improved fixed day rates suggesting strengthening market conditions.

Positive rating actions are unlikely over the short- to medium-term given the weak offshore market. A formalization of the amendments to the contracts including the provision to set a minimum day rate, and the further extensions of the contracts could result in a revision to the Negative Rating Watch.

Negative: Future developments that may, individually or collectively, lead to a negative rating action include:
-- Through-the-cycle consolidated debt/EBITDA of 5x or above on a sustained basis;
-- Contracts are not rolled over within six months after expiration or contracted day rates experience further pressure and are significantly lower than current market dayrates as a result of not executing the amendments to the contracts to set a minimum day rate;
-- The company faces delays of six months or greater contracting new equipment after it is delivered;
-- The company fails to execute the amendment for the extension of Centenario beyond December 2015.

LIQUIDITY AND DEBT STRUCTURE
ODH's liquidity position is supported by the company's stable and predictable cash-flow generation coupled with a lengthened debt maturity profile. ODH's liquidity position is supported by its cash on hand, which as of June. 30, 2015, was approximately USD194.3 million. The company also had USD106.2 million in restricted cash investments associated with the required debt service reserve account for the 2020 notes and the bank loan related to the financing of La Muralla IV. As of June 2015, the company had no short-term debt.

RECOVERY ANALYSIS
The ratings of ODH's senior secured notes are notched above ODH's IDR as a result of the relative recovery prospects in a hypothetical default scenario under Fitch's 'Recovery Ratings and Notching Criteria for Non-Financial Corporates Issuers' criteria report.

Fitch has assigned an 'RR3' rating to ODH's senior unsecured notes. The 'RR3' rating reflects a one-notch positive differential from the 'B+' IDR and indicates good recovery prospects given default. 'RR3' rated securities have characteristics consistent with securities historically recovering 51%-70% of current principal and related interest.

KEY ASSUMPTIONS
-- Centenario is recontracted at a day rate of $365 thousand until December 2017;
-- Bicentenario is recontracted until December 2017 at a rate of $365 thousand;
-- La Muralla IV remains contracted at the existing day rate of $489 thousand until 2018;
-- After expiration of the contracts for the semisubmersibles (2017), market day rates recover;
-- Daily operating expenses for the semisubmersibles of $170 thousand;
-- Regular maintenance capex of approximately $90 million during the next five years;
-- Peak leverage in 2015 with the financing of the additional jack-ups with leverage returning to levels below 4.5x for the next three years.

FULL LIST OF RATING ACTIONS

Fitch has downgraded ODH's ratings as follows:

-- Foreign and local currency IDRs to 'B+' from 'BB-', placed on Negative Watch
-- Senior secured notes to 'BB-' from 'BB', assigned a Recovery Rating of 'RR3'.