Moody's Raises Chesapeake Energy (CHK) to 'Ba1'; Notes Leverage Reduction

Moody's Investors Service upgraded Chesapeake Energy Corporation's (NYSE: CHK) Corporate Family Rating (CFR) to Ba1 from Ba2 and the company's senior unsecured notes ratings to Ba1 from Ba3. Moody's also raised Chesapeake's Speculative Grade Liquidity Rating to SGL-2 from SGL-3. The rating outlook is stable.

"The upgrade of Chesapeake Energy's ratings to Ba1 reflects the substantial leverage reduction expected from its announced asset sales and oilfield services business spin-off," commented Pete Speer, Moody's Senior Vice President. "The company has shown stronger capital discipline and is making meaningful progress on reducing its organizational and financial complexity."

RATINGS RATIONALE

Chesapeake announced several asset sales agreements and a definitive plan to spin-off Chesapeake Oilfield Operating (Ba2, under review for downgrade; renamed Seventy Seven Energy) by the end of June 2014 that will reduce its adjusted debt by almost $2.5 billion. The transactions are also expected to raise cash proceeds of $915 million. Pro forma for these transactions, the company's leverage on average daily production and proved developed (PD) reserves declines to around $21,500/boe and $8/boe, respectively, at March 31, 2014. Stronger natural gas prices combined with the leverage reduction should increase pro forma March 31, 2014 retained cash flow (RCF)/debt of 29% towards 35% by the end of 2014. This leverage reduction appears sustainable and is supportive of an upgrade to Ba1.

The company's liquidity rating was upgraded to SGL-2 from SGL-3 in response to Chesapeake's significant cash balance following these transactions and full availability on its $4 billion senior secured credit facility. Pro forma for the announced transactions Chesapeake had $1.9 billion of cash at March 31, 2014, which should fully cover its planned capital expenditures in excess of operating cash flow for the remainder of 2014. The company is guiding towards capital expenditures approximating cash flows in 2015. This greatly improved ability to live within internally generated cash flows and cash balances leaves the revolver as ample liquidity for working capital and commodity price fluctuations. Chesapeake has good headroom for compliance under its revolver covenants and we expect that to be maintained as the company continues to hedge a significant portion of its future production.

The upgrade of the senior notes ratings to Ba1 from Ba3 reflects both the overall probability of default of Chesapeake, which was upgraded to Ba1-PD, and a loss given default of LGD 4 (58%). The reduced probability of default combined with the much lower expected utilization of the $4 billion senior secured revolving credit facility resulted in the senior unsecured notes being rated the same as Chesapeake's Ba1 CFR. The size of the potential priority claim to the assets relative to the senior unsecured debt outstanding was not large enough to result in a notching down of the senior notes from the CFR under Moody's Loss Given Default Methodology.

Chesapeake's Ba1 CFR incorporates the benefits of its very large proved reserve and production scale, sizable high quality acreage positions in multiple basins across the US, and competitive drillbit finding and development (F&D) costs. The rating also reflects the company's improving leverage metrics and declining financial complexity. The ratings are restrained by the company's still high exposure to natural gas and low price realizations caused by a relatively high cost burden for gathering and transporting its production. While Chesapeake has benefited from stronger natural gas prices in 2014, its cash margins, leveraged full-cycle returns and cash flow coverage of debt remain weaker than most investment grade rated peers.

If Chesapeake can increase its cash margins and returns while continuing to achieve its organic reserves and production growth targets and improving its leverage metrics then the ratings could be upgraded to Baa3. A leveraged full-cycle ratio approaching 2x with RCF/debt sustained above 40% could result in a ratings upgrade. Conversely, a significant increase in financial leverage could pressure the ratings. RCF/debt below 25%, debt/PD above $10/boe, or debt/average daily production above $25,000/boe could result in a ratings downgrade.

Upgrades:

..Issuer: Chesapeake Energy Corporation

.... Corporate Family Rating, Upgraded to Ba1 from Ba2

.... Probability of Default Rating, Upgraded to Ba1-PD from Ba2-PD

....Senior Unsecured Conv./Exch. Bond/Debenture, Upgraded to Ba1, 58-LGD4 from Ba3, 62-LGD4

....Senior Unsecured Regular Bond/Debenture, Upgraded to Ba1, 58-LGD4 from Ba3, 62-LGD4

....Senior Unsecured Shelf, Upgraded to (P)Ba1 from (P)Ba3

.... Speculative Grade Liquidity Rating, Upgraded to SGL-2 from SGL-3

Outlook Actions:

..Issuer: Chesapeake Energy Corporation

....Outlook, Remains Stable

The principal methodology used in this rating was the Global Independent Exploration and Production Industry published in December 2011. Other methodologies used include Loss Given Default for Speculative-Grade Non-Financial Companies in the U.S., Canada and EMEA published in June 2009. Please see the Credit Policy page on www.moodys.com for a copy of these methodologies.

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