OREANDA-NEWS. Fitch Ratings has downgraded Chesapeake Energy Corporation's (Chesapeake; NYSE: CHK) Long-term Issuer Default Rating (IDR) to 'B' from 'BB-'. The Rating Outlook remains Negative. A full list of rating actions is provided at the end of this release.

In addition, Fitch expects to rate the company's planned second lien notes issuance 'BB-'/RR2. Chesapeake announced the early tender extension and upsizing of private offers of up to $3 billion from $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. 18 and Dec. 30, 2015, respectively. Fitch believes that the exchange offer will help to materially reduce overall balance sheet debt, but early tenders suggest the exchange will have limited impact on the company's near-term maturities profile. The exchange is also likely to modestly decrease cash interest payments based on early results.

The downgrade reflects the limited near-term liquidity relief provided by the exchange and the potential for low hydrocarbon prices (in particular the recent drop in natural gas prices to below $2.00/mcf) to negatively impact the company's plans to raise liquidity through asset sales. Fitch believes asset sales are likely to be natural gas focused given management's long-term strategy to increase its liquids-focused production mix. Ultimately, the company is expected to use its large, diversified asset base to manage their medium-term operational and financial obligations currently providing a margin of safety at the 'B' level. Fitch believes there is an adequate number of peer and financially-backed E&P companies that have a considerable amount of capital looking to be deployed for M&A.

The Negative Outlook reflects heightened asset sale execution risk, as well as the potential for further deterioration of the company's free cash flow (FCF) profile. In our view, the private exchange offer signals management's difficulty selling assets in the current stressed hydrocarbon pricing environment to help address forecast FCF shortfalls and debt maturities.

Fitch does not currently view the pending 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. Furthermore, the exchange is largely opportunistic and not necessary to avoid a near-term bankruptcy or payment default. The company has $1.7 billion of cash on hand as of Sept. 30, 2015, full availability under its $4 billion secured revolver with ample unencumbered collateral mitigating the risk of material borrowing base reductions, and a large, diversified reserve base, parts of which should be able to be sold off to help improve liquidity.

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. In the near term, the sharp drop in U.S. natural gas prices linked to a strong El Nino weather pattern have also weighed on the company. 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 unfavorable 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, predicts debt/EBITDA of approximately 5.4x and 9.7x in 2015 and 2016, respectively.

KEY ASSUMPTIONS

Fitch's key assumptions within our 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 $3.50/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 on 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 5.5x-6.0x on a sustained basis;
--Balance sheet debt/flowing barrel under $35,000 - $40,000 and/or debt/1p below $8.00 - $8.50/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 6.5x - 7.0x on a sustained basis;
--Balance sheet debt/flowing barrel of $45,000 - $50,000 and/or debt/1p above $9.00 - $9.50/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

Pro forma cash & equivalents, as of Sept. 30, 2015, were nearly $1.4 billion, considering the November 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 million - $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 billion, and $1.5 billion due in 2016 - 2019. These amounts exclude the effects of the pending exchange and 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.

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 first quarter 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 amended and increased its ability to incur junior lien debt to up to $4 billion from $2 billion. 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 downgraded the following ratings:

Chesapeake Energy Corporation
--Long-term IDR to 'B' from 'BB-';
--Senior secured bank facility to 'BB/RR1from 'BB+'/RR1;
--Senior unsecured notes to 'B/RR4' from 'BB-/RR4';
--Convertible preferred stock to 'CCC+/RR6' from 'B/RR6'.

The Rating Outlook remains Negative. Additionally, Fitch has removed the senior unsecured notes Rating Watch Negative due to the result of our bespoke recovery analysis and additional clarity as to the potential size of the new second lien notes and possible reduction in unsecured notes.

Fitch also expects to rate the senior secured second lien notes as follows:

--Senior secured second lien notes 'BB-/RR2'.