TEXT-S&P rates Patriot Coal's DIP facility 'BB-'
Aug 16 - Overview -- Patriot Coal Corp. has obtained $802 million of debtor-in-possession (DIP) credit facilities consisting of $500 million of new money facilities and a $302 million roll-up facility for outstanding pre-bankruptcy letters of credit. -- We are assigning point-in-time ratings to Patriot's $500 million "new money" DIP credit facilities. We are rating the $125 million DIP revolving credit facility 'BB-' and the $375 million DIP term loan 'B+'. Rating Action On Aug. 16, 2012, Standard & Poor's Ratings Services assigned its 'BB-' rating to St. Louis, Mo.-based Patriot Coal Corp.'s $125 million debtor-in-possession (DIP) revolving credit facility and its 'B+' rating to its $375 million DIP term loan. The corporate credit rating on the company remains 'D'. Rationale Patriot Coal Corp. and certain of its U.S. subsidiaries filed a voluntary petition under Chapter 11 of the U.S. Bankruptcy Code on July 9, 2012. On July 10, 2012, the U.S. bankruptcy court in the Southern District of New York issued an interim order that authorized the company to borrow up to $677 million of the $802 million DIP facilities. On Aug. 2, 2012, the bankruptcy court issued a final order authorizing access to the full amount under the DIP facilities. The DIP facilities constitute super priority administrative expense claims. A Standard & Poor's rating on a DIP facility reflects our view of the likelihood of full cash repayment through the company's reorganization and emergence from Chapter 11. A rating on a DIP facility also acknowledges potential ratings enhancement if we believe the assets securing the facility will likely facilitate a full recovery if liquidation becomes necessary. Our ratings on both the revolving credit facility and the term loan incorporate a 'B' assessment of the likelihood of cash repayment through Patriot's reorganization and emergence from Chapter 11. We applied a one-notch enhancement to the term loan rating and a two-notch enhancement to the revolving credit facility based on our assessment of recovery prospects under a liquidation scenario. These DIP loan ratings are point-in-time ratings. Accordingly, the ratings are effective only for the date of this report, and we will not review, modify, or provide ongoing surveillance of the ratings. These ratings are based on, among other things, the credit agreement dated July 9, 2012, and the interim order and final orders issued by the U.S. bankruptcy court dated July 10, 2012, and Aug. 2, 2012. We believe Patriot's bankruptcy filing was prompted by a number of factors, including: -- Difficult industry conditions stemming from a warmer-than-normal winter that reduced demand for electricity, the substitution of low-cost natural gas for coal in electricity generation, and increasingly stringent safety and environmental laws. These unfavorable conditions have accelerated what we view as a sustained decline in the economic viability of thermal coal produced in the Central Appalachia (CAPP) basin; -- Fewer production disruptions in Australia and slowing global demand have caused metallurgical (met) coal prices to decline; -- High ongoing costs related to certain labor agreements and legacy liabilities; -- Sales contract deferrals and the failure of two significant customers to honor purchases; and -- The company's inability to refinance its 2013 maturities, including a $428 million revolving credit facility and a $125 million accounts receivable securitization facility, which as of March 31, 2012, had $329 million of letters of credit outstanding. Still, we believe that Patriot remains a viable business, and the company's reorganization and emergence from bankruptcy are supported by: -- Its asset base, including a large reserve base that includes a number of mines with attractive cost structures; -- Its strategy to focus mining operations on higher-margin met coal and its lower cost steam coal mines, which should enhance profitability over the long term; and -- The possibility that it may gain some union concessions and exit underwater contracts and uneconomic leases, which should result in lower costs and better profit and cash flow potential. We currently believe the DIP financing provides the company with sufficient liquidity to effectively conduct its business throughout the bankruptcy process. While we believe that reorganization is a more likely scenario for the company than liquidation, the ratings reflect our assessment that various factors could hinder the company's ability to reorganize and emerge from Chapter 11. Those factors include: -- A continued secular decline in demand for thermal coal, as well as a prolonged cyclical decline in met coal demand, which could continue to depress prices and increase Patriot's cash burn; and -- Difficulties in adequately restructuring legacy liabilities and labor agreements, which would pressure earnings and Patriot's cost-competitiveness. In assessing the likelihood that Patriot will fully repay the DIP revolving credit facility and DIP term loan through its reorganization and emergence, we assumed that: -- $375 million would be outstanding under the DIP term loan, reflecting our assumption that none of the outstanding principal would be prepaid prior to emergence. -- No more than $65 million of DIP revolving borrowings would be outstanding. This reflects the maximum amount we assume would be available (after considering the borrowing base, reserve, and other availability limitations pursuant to the DIP credit agreement). -- All letters of credit under the $302 million DIP letter of credit facility would remain undrawn during the Chapter 11 proceeding, and the company would replace them upon emergence. Although we think the going concern value of a reorganized Patriot will likely exceed the amount of DIP financing that it would have to repay in full in cash upon emergence, the extent of the cushion is difficult to assess. In our view, a fair degree of unpredictability surrounds Patriot's ultimate reorganization value as a result of the sector's volatility, as well as the uncertainties relating to Patriot's potential pension and OPEB cost savings, operating cost reductions, and lease and contract rejections. As we see it, the higher the enterprise value in the eyes of market participants (over and above the amount of the DIP facilities), the lower the refinancing risk that DIP lenders face. At this point, we assume that Patriot's emergence value will not substantially exceed the amount of the DIP facilities. On the basis of the analytical considerations described above, our DIP ratings reflect a 'B' risk assessment of the likelihood that Patriot will repay DIP lenders in cash in full at the point of its reorganization and emergence from Chapter 11. Valuation/collateral coverage As part of our DIP loan rating analysis, we assessed prospects for repayment of principal in the event that Patriot is unable to reorganize and the bankruptcy proceeding is converted into a Chapter 7 asset liquidation. In our view, coal asset valuations pose a significant challenge, especially given the heightened potential for extreme distress inherent in a liquidation scenario. While we believe that our analysis reflects a reasonable degree of conservatism, we emphasize that the assumptions and estimates underlying our liquidation valuation are subject to uncertainties, contingencies, and future developments that are difficult to predict. Coal markets are volatile. On the metallurgical side, asset values are affected by the global demand for steel. Thermal coal prices tend to fall during periods of declining electricity consumption and low natural gas prices. In addition, we expect Central Appalachian thermal coal valuations to remain depressed-perhaps severely so-given the regulatory, operating, and other challenges unique to that region. Our analysis reflects the following assumptions about payment priorities based on the terms of the bankruptcy court orders and the credit agreement: -- The DIP facilities have a first priority claim on net asset liquidation proceeds, except for up to $7 million of claims that have a court-approved higher priority. -- The $125 million DIP revolving credit facility and the $375 million DIP term loan have a "first out" position, and the $302 million DIP letter of credit facility has a "second out" position. -- The DIP revolving credit facility has a first priority claim on accounts receivable and a second priority claim on all other assets, and the DIP term loan has a first priority claim on all assets other than accounts receivable, and a second priority claim on accounts receivable. Our liquidation analysis also reflects the following: -- We understand that Patriot has approximately 1.9 billion tons of proven and probable coal reserves. -- We assumed that the company would owe about $65 million under the DIP revolving credit facility, reflecting the maximum amount we assumed Patriot would be able to borrow or use for letters of credit in light of borrowing base, reserves, and availability limitations imposed by the credit agreement. -- We assumed that $375 million would be outstanding under the DIP term loan. Metallurgical coal assets. We arrived at a gross liquidation value for Patriot's metallurgical coal reserves and related assets of roughly $275 million. This estimate includes accounts receivable, inventory, and machinery and equipment that we assume would be allocable to Patriot's metallurgical coal business. In our view, Patriot's Rocklick and Wells reserves, which consist of typically higher value "High-Vol A" reserves are worth more than Patriot's other metallurgical coal reserves on a price-per-ton basis. Thermal coal assets. We arrived at a gross liquidation value for Patriot's thermal coal reserves and related assets of roughly $300 million. This estimate includes accounts receivable, inventory, and machinery and equipment that we assume would be allocable to Patriot's thermal coal business. We note, however, that we ascribed no value to reserves that we understand are not under development or associated with any of Patriot's key mining complexes. Net liquidation proceeds. After accounting for liquidation and wind-down costs and priority "carve-out" claims, we estimate that approximately $500 million of asset liquidation proceeds would be available for distribution to DIP lenders under our analysis. Coverage. Based on our analysis, we believe that the net distributable value of Patriot's assets would exceed the amount of the DIP revolving and term loan facilities in a liquidation scenario. While our analysis suggests that both facilities benefit from some measure of overcollateralization, we think that DIP revolving lenders are more favorably positioned from a recovery perspective. In our view, this advantage stems from the first priority claim that the DIP revolving credit facility has on accounts receivable, which is a more liquid form of collateral, together with the borrowing base and reserve protections contained in the credit agreement. As a result, we applied a two-notch enhancement (the maximum achievable under our DIP ratings framework) to our underlying risk assessment of 'B', which results in an overall DIP revolving credit facility rating of 'BB-'. For the DIP term loan, we applied a one-notch enhancement to our underlying risk assessment of 'B', which results in an overall DIP term loan facility rating of 'B+'. Related Criteria And Research -- Update on Rating Methodology For Debtor-in-Possession Loans With Non Cash Pay Features, July 30, 2009 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Patriot Coal Corp. Corporate credit rating D New Rating Patriot Coal Corp. Senior secured $125 million revolver BB- $375 million term loan B+ Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.