NEW YORK, May 17 (IFR) - Credit markets are signaling
steadily growing concerns about troubled oil and gas producer
Chesapeake Energy, raising pressure on the company to deliver on
its strategy of planned asset sales.
The company's bonds, protection on those bonds and its
shares have all been battered in recent months following a
series of Reuters reports revealing potential conflicts of
interest in loans extended by the company to Chief Executive
Aubrey McClendon against personal stakes in the company's wells.
The reports have come as Chesapeake grapples with a
2012 funding shortfall of $9 billion to $10 billion as natural
gas prices remain at their lowest in a decade. The company
managed this week to tap the capital markets for a $4 billion
bridge loan -- but investors are still worried.
"They need too large of an asset sale over too short of a
time, otherwise they are going to have a liquidity crisis," said
Marc Gross, portfolio manager at RS Investments' high-yield and
floating-rate bond funds.
"All of the problems they are having today is because they
didn't expect $2 gas, and it's hurting them a lot more than they
are letting on. The company is under stress," he said.
The cost of insuring Chesapeake bonds against potential
default jumped on Thursday after hedge fund manager T Boone
Pickens dumped 71,000 of its shares.
Five-year credit default swaps were last trading 26 basis
points wider at a record wide of 887, surpassing the previous
historical wide of 828 seen in Jan, 2009.
That means it costs $887,000 a year for five years to insure
$10 million of debt. Shares were down 19 cents at $13.85.
Shorter-term contracts are looking even more ominous, with
one-year CDS close to 1,000, about double its level a week ago.
The one-year contract is less liquid than the five-year and
can balloon wider or compress swiftly due to market technicals.
But it is highly sensitive to the market's perception of credit
SENTIMENT FADING FAST
The CDS price movement has been accompanied by an increase
in net notional, or CDS positions, as measured by data provided
by the Depository Trust Clearing Corp.
Data for the four-week period ending May 12 shows a more
than 10 percent increase in dollar equivalent to about $1.3
billion, suggesting a rapid deterioration in sentiment and in
The company's CDS credit curves have dramatically flattened
in the one-month period and several are now inverted, suggesting
investors are even more fearful about what's ahead.
Standard & Poor's this week expressed concern about a
covenant breach in the next three quarters as the company's debt
levels climb. The company's loan covenants already state its
debt cannot exceed 4 times its lagging 12-month EBITDA. Total
debt as of March 31, 2012 was $13.1 billion, while EBITDA was
weak, at $838 million.
S&P downgraded the credit to BB-, citing "increased funding
risk stemming from weak internal cash generation and very heavy
capital expenditures," alongside the revelations about the CEO's
tangled personal financial transactions.
It was the second downgrade in three weeks and comes after
Moody's a week earlier changed the outlook on its Ba2 rating to
negative from stable.
"Their entire thesis has changed over the last couple of
weeks," said Gross. "This was a company that said they had
investment grade metrics and in the short term would be an
investment grade company, and now they've been downgraded
Philip Adams, credit strategist at GimmeCredit, agreed.
"This story would not have as much traction if natural gas
was at $6 per million cubic feet and CHK was "A"rated and
generating gobs of free cash flow," he said. "One of the
consequences of being sub-investment grade is that spread
volatility can be 'manic."
Chesapeake's bonds have been some of the most active and
worst performing credits for the past several weeks.
Chesapeake's benchmark 6.625% notes due 2020 traded at 90.50
today (Thursday), down two points from yesterday. Since May 1,
the 6.625% notes have dropped over eight points.
"They are fading back to a mid high-yield company, so the
class of investors changes," said Gross. "It's now a true high
yield play, and with some hair on it, because of the
investigations and disclosures, and Chesapeake has had to
migrate into different hands."
Hedge fund and pure high-yield funds have replaced insurance
companies and pension funds as holders of the debt as the notes
get downgraded, forcing higher quality funds to sell out of the
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