While spring is typically a time for optimism and new beginnings, many energy investors had an ominous feeling this spring. That's because the sector's banks would be reviewing the credit they had extended to producers and were expected to be very stringent given the significant deterioration in oil and gas prices since banks last reviewed credit in the fall. There was a grave concern that banks would be so stringent that it could lead to a mass casualty event with a number of producers being forced into bankruptcy.
Those concerns, however, haven't been realized after banks have been far more lenient than expected, at least with Chesapeake Energy (NYSE:CHK). That's after they reaffirmed the company's $4 billion credit line and agreed not to review it again until June 2017. That provides the company with clear visibility on liquidity for more than a year, which is a huge relief given the company's grave credit concerns.
Clarity on liquidity
Chesapeake Energy's banks gave it a big shot in the arm after reaffirming its borrowing base at $4 billion. While the company hadn't borrowed anything on its credit line just yet, it burned through much of its cash balance last year leaving its liquidity uncertain because its banks could have cut deeply into its borrowing base.
So far though, banks have been very lenient with these credit lines. Fellow oil and gas producer WPX Energy (NYSE:WPX), for example, recently received $1.2 billion in commitments on its credit line, despite unloading $1.2 billion in assets that had backed its facility since the start of this year. Not only that, but WPX Energy's banks amended the facility's terms and covenants to give it "increased flexibility and full access to the facility." As such, it provides a lot of clarity as well as ample liquidity for WPX Energy to use during the downturn.
A lot more breathing room
Chesapeake Energy, likewise, not only saw its banks leave its borrowing base intact, but they provided even more relief. One of the key points of relief being an agreement not to schedule another redetermination until next June. That effectively locks in the company's liquidity through the next year, removing the risk of another redetermination this fall and early next spring.
Further, its banks also granted it some relief on its covenants. They agreed to temporarily relieve its senior secured leverage ratio by suspending it until September of next year, when it will revert to 3.5 times until next December before falling to three times thereafter. Additionally, they reduced the company's interest coverage ratio to 0.65 times from 1.1 times through next March, before it incrementally increases up to 1.25 times by next September.
That said, Chesapeake Energy must agree to maintain at least $500 million of liquidity at all times, which would increase to $750 million if its collateral ratio falls below 1.1 times. However, it was granted the ability to incur up to $2.5 billion of first lien debt as long as it remains on equal footing with the credit facility.
Why this matters to Chesapeake Energy
In a nutshell, this agreement buys Chesapeake Energy valuable time because it now has ample liquidity for more than a year to sort out its balance sheet issues. The company is now free to use its credit to pay off looming debt maturities or fund drilling without having to worry that its line will be cut this fall should oil and gas prices take another tumble. Further, it gives it time to pursue asset sales or debt swap transactions without being under duress.
This is a real positive for Chesapeake Energy, and for the energy sector in general. If Chesapeake Energy's liquidity ran dry and it had to declare bankruptcy that event could have taken an out sized portion of the sector down with it. While this agreement doesn't guarantee Chesapeake Energy, or the industry at large, won't face that threat in the future, it does kick the can down the road so to speak. The hope being that in a year's time oil and gas prices will have improved to the point where the company's cash flow can better support what will hopefully be an improved balance sheet after company completes some more asset sales and debt restructuring.
Matt DiLallo has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.