Fitch: US HY E&P Asset Coverage Weaker But Pockets of Strength

NEW YORK & CHICAGO--(BUSINESS WIRE)-- Asset coverage for high yield (HY) unsecured exploration and production (E&P) debt has weakened due to declining prices but pockets of strength exist, reflecting cost profile, capital structure and hedge positions, according to Fitch Ratings.

Recent subordination of unsecured debt to new junior-secured debt had a significant impact on unsecured debt asset coverage estimates at several issuers, including HK, EXXI, SD, MPO, LINE and BBEP. Junior-secured issuance was primarily used to shore up liquidity by providing cash or reducing first-lien bank debt in advance of reduced borrowing bases. This liquidity, while crucial for HY E&P companies at this point in the cycle, tended to lower the prospects for unsecured bondholders in the event companies are forced into bankruptcy.

Fitch's recent analysis of 20 HY E&P companies focused on prospects for asset coverage of unsecured debt based on the present value of proved reserves and other assets such as cash and derivatives. The analysis identified cost structure, balance sheet leverage and price as key factors. Unsurprisingly, while coverage drifted lower in stress price scenarios, there were distinct winners and losers. Results suggest HY E&P credit risk is widely dispersed and, while not the norm, some relatively strong balance sheets exist at the 'B' rating level.

Credit quality at several HY E&Ps is capped primarily by size and scale, not necessarily pure balance sheet leverage, presenting opportunities for investors to differentiate HY risk factors. Recent credit market volatility highlights the importance of identifying and clarifying E&P risk factor exposures.

In the long run, the company does not control price as the ability to economically hedge is likely to drop in an extended downturn. This underscores the importance of prudent through-the-cycle balance sheet management and good cost control in maintaining E&P companies' asset value and, ultimately, credit quality. Companies with more resilient coverage in Fitch's stress cases generally exhibit these traits.

Asset sales can potentially serve as a means to deleverage but can have longer term implications, including lower production volumes or the loss of jewel asset positions, particularly for smaller, single-basin companies. This may be why HY E&P companies with weaker asset values in Fitch's sample have looked to address capital structure issues externally with stakeholders through debt exchanges and open-market debt repurchases.

The full report "High-Yield E&P Asset Coverage (Capital Structures, Cost Positions in Focus)," dated January 2016, is available at www.fitchratings.com.

Additional information is available on www.fitchratings.com.

The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article, which may include hyperlinks to companies and current ratings, can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.

High-Yield E&P Asset Coverage (Capital Structures, Cost Positions in Focus)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=875760

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View source version on businesswire.com: http://www.businesswire.com/news/home/20160113006190/en/

Fitch Ratings
Brad Bell
Associate Director, US Oil & Gas
+1 312 368-3149
70 W Madison Street
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or
Dino Kritikos
Director, US Oil & Gas
+1 312 368-3150
or
Kellie Geressy-Nilsen
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Source: Fitch Ratings

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