Fri 05/01/2020 15:36 PM
Relevant Items:
Centennial Resource Covenants Tear Sheet, Debt Document Summary
Centennial Resource Debt Documents

Centennial Resource is conducting a distressed exchange under which it is offering the holders of its $900 million of unsecured notes $450 million of new second lien and third lien notes and is seeking consents from a majority of the unsecured noteholders to eliminate the unsecured notes’ negative covenants. The exchange is conditioned on the company obtaining an amendment to its RBL facility which would, among other things, permit the issuance of the new secured notes.

The exchange is not subject to a minimum participation and, because the unsecured notes provide the company with sufficient secured debt capacity to issue the new secured notes, to the extent holders of a majority of the unsecured notes do not tender their notes, the company could still consummate the exchange.

Although the company is seeking to replace a 4x total leverage financial maintenance covenant under its RBL facility with a first lien maintenance covenant, it did not disclose whether it would seek to amend the 1x current ratio maintenance covenant.

The company is currently in compliance with the 1x current ratio, but because its current liabilities exceeded its current assets as of Dec. 31, 2019, the company is likely unable to fully utilize the $349 million of revolving availability it has disclosed in the exchange documentation.
 
Background

On April 22, Centennial Resource announced an offer to exchange its $900 million of unsecured notes for $250 million of second lien and $200 million of third lien notes at 50% of par and, as part of the exchange, was seeking consents from unsecured bondholders to “eliminate substantially all of the covenants in the unsecured note indentures.”

Holders of the existing notes that tender (i) before Tuesday, May 5, at 5 p.m. will receive 50 cents on the dollar for their existing notes and (ii) thereafter will receive 45 cents on the dollar for their existing notes. The company will issue the second lien notes before issuing the third lien notes and, assuming full participation by May 5, expects that the unsecured noteholders will receive $277.78 of second lien notes and $222.22 of third lien notes for each $1,000 of existing notes tendered. The exchange is not subject to a minimum participation threshold.

The company’s capital structure as of Dec. 31, 2019, assuming full participation in the exchange and the company’s disclosure that, as of April 21, $275 million of debt was outstanding under its RBL facility, is illustrated below for reference.
 

The issuance of the second and third lien notes is conditioned on, among other things, the company obtaining an amendment to its RBL facility, which it expects to:
 
  • Reduce the RBL facility’s borrowing base from $1.2 billion to $700 million;
     
  • Permit the issuance of the second and third lien notes;
     
  • Replace the 4x total leverage covenant with a first lien leverage covenant; and
     
  • Add a minimum availability condition to access the revolver that will require that revolving commitments equal to the lesser of $75 million and 25% of the aggregate outstanding secured notes at issuance be available after the issuance of the secured notes.
In this article, we discuss the company's proposed notes exchange and amendments to its RBL facility.
 
The RBL Facility’s Financial Maintenance Covenants and Liquidity

The RBL facility requires Centennial Resource to comply with a 4x total net leverage ratio (which permits all unrestricted cash to be netted) and a 1x current ratio (calculated as the ratio of (i) current assets plus revolver availability to (ii) current liabilities, excluding the current portion of any long-term debt maturities).

As of Dec. 31, 2019, pro forma for the exchange and assuming $275 million of the RBL facility is currently drawn, Centennial Resource’s total net leverage would have been about 1.2x, and the company could have incurred about $1.7 billion of additional debt and remained in compliance with the 4x test.
 

However, in the exchange documentation, the company has disclosed that, as part of the amendment to the RBL facility, the total leverage maintenance covenant will be replaced with a first lien leverage covenant and that:
 
“If we do not receive our requested waivers and amendments we currently do not expect to comply with the total funded debt to EBITDAX ratio covenant in the next twelve to eighteen months.”

Because the company does not expect that it can remain in compliance with the 4x total leverage test, it is projecting that its EBITDAX could decline by about 71% over the next 12 to 18 months.

The company’s current ratio as of Dec. 31, 2019, pro forma for the exchange and for the $275 million of revolving borrowings, was about 1.8x - putting it comfortably above the 1x threshold, given its $254 million of current liabilities is more than twice its $118 million of current assets. But to remain in compliance the company will need to ensure that $136 million of RBL commitments remain either undrawn or the cash proceeds from any draw are added to the company’s balance sheet cash.
 

As such, although the company has disclosed that, as of April 21, pro forma for the exchange and in light of the minimum availability condition that will be added to the RBL facility, revolving availability was $349 million and its cash balance was $9 million, the company had only $213 million of liquidity that it could actually use to fund operations.
 
 
Negative Covenant Capacities
 
RBL Facility

The current negative covenant package under the RBL facility is illustrated below.
 

Although the $800 million RBL facility permits Centennial Resource to increase commitments up to $1.5 billion, subject to borrowing base restrictions, it does not currently permit any additional secured debt, regardless of whether such secured debt is pari or junior. Additionally, although the RBL facility includes a general liens basket, because the only other general-purpose debt baskets - a basket for “Permitted Senior Unsecured Notes” and a general debt basket - are explicitly required to be unsecured, such lien capacity is unable to be used.

The RBL facility also restricts the company from voluntarily prepaying Permitted Senior Unsecured Notes, which includes the existing unsecured notes, unless such prepayments are funded with the proceeds of new Permitted Senior Unsecured Notes or with proceeds from equity issuances.

As such, in order to issue the new secured notes, Centennial Resource must amend the RBL facility to both permit it to issue junior lien debt and to prepay the existing unsecured notes with such junior debt.

The RBL facility also (i) permits the company to incur about $1.7 billion of Permitted Senior Unsecured Notes under the 4x total net leverage covenant, (ii) does not currently restrict the company from paying dividends or buying back its stock, given that the company can meet a 3x total net leverage test and access a leverage-based restricted payment basket and (iii) permits the company to transfer $50 million of assets to unrestricted subsidiaries.
 
New Secured Notes vs. Existing Unsecured Notes

As mentioned, in connection with the exchange, Centennial Resource is soliciting consents to “eliminate substantially all of the restrictive covenants and certain of the default provisions contained in the Old Notes Indentures.” However, it is notable that, as illustrated below, because the existing unsecured notes provide sufficient secured debt capacity for Centennial Resource to issue the secured notes, there is no actual need to eliminate the unsecured notes’ restrictive covenants to consummate the exchange.
 

Under both the existing unsecured notes and the new secured notes, capacity is based, in part, on a percentage of the company’s adjusted consolidated net tangible assets, which itself is based on the company’s PV-10. The unsecured notes calculate PV-10 based on SEC pricing (based on the twelve-month trailing average West Texas intermediate posted price), but the secured notes use a modified ACNTA calculation that is based on strip pricing (based on the closing monthly future prices as reported on the Nymex).

As illustrated below, using pricing as of Dec. 31, 2019 (because oil prices have significantly declined since then, the company’s PV-10 based on strip pricing is likely significantly less than it was as of Dec. 31, 2019), the company’s ACNTA under the unsecured notes is currently about $3.6 billion, while under the secured notes, it is currently about $2.6 billion.
 

Because of the higher ACNTA figure, the unsecured notes would permit Centennial Resource to incur an additional $874 million of secured debt (or $349 million assuming a fully drawn revolver) after the issuance of the secured notes and adjusting for $275 million of outstanding debt under the RBL facility and provide the company with $69 million of additional restricted payment capacity.

Nevertheless, after their issuance and adjusting for $275 million of outstanding debt under the RBL facility, the secured notes would permit the company to incur only $424 million of additional priority lien secured debt (or $75 million assuming a fully drawn revolver) and $53 million of debt secured on a pari basis with the second lien notes.

The secured notes also permit the company to make $35 million of restricted payments (which could also be used for investments and prepayments), $53 million of transfers to unrestricted subsidiaries and, under the second lien notes, $30 million of purchases of the third lien notes; additional shared capacity based on 50% of CNI from Oct. 1, 2017, to the extent it is positive, is also available.
 
Sale of Saltwater Transportation and Disposal Facilities

On Feb. 4, 2020, the company announced that it had agreed to sell its saltwater transportation and disposal facilities in Texas’ Delaware Basin to WaterBridge Texas Midstream LLC for $150 million; the transaction is expected to close in May 2020.

Both the RBL facility and the new secured notes generally permit the company to sell assets. The RBL facility does not require asset sale proceeds be used for any specified purpose but does require that the borrowing base be automatically reduced if borrowing base properties constituting more than 5% of the then-effective borrowing base are sold. In contrast, the new secured notes require that proceeds in excess of $5 million be used to either repay debt or reinvest in the business; the saltwater transportation and disposal facilities are not borrowing base properties.

The third lien notes permit the company to use asset sale proceeds to prepay the second lien notes at par, and both series of secured notes permit proceeds to be used to repay outstanding revolver borrowings without having to permanently reduce revolving commitments.

However, as mentioned above, because the RBL facility currently does not permit the company to prepay any outstanding debt other than with the proceeds of refinancing debt or equity issuances, and because using asset sale proceeds to prepay the secured notes would constitute a prepayment under the RBL facility, absent an amendment to these provisions, the company can likely only use proceeds from the sale of the transportation and disposal facilities to reinvest in the business.
 
Change of Control

One final issue of note is the fact that the secured notes’ change of control put is subject to a double trigger: there must be both a change of control and a ratings downgrade.

Given how financially distressed Centennial Resource currently is, it is hard to imagine the company being further downgraded if it were acquired. As such, to the extent the company is acquired, noteholders would likely not be able to put their notes to the company at 101.
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