Fitch Affirms Chesapeake Energy's IDR at 'BB-'; Outlook 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.
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