Encino Acquisition Partners LLC Downgraded To 'B-'; Outlook Remains Negative

  • We expect Encino Acquisition Partners LLC's funds from operations to debt and debt to EBITDA metrics to weaken substantially on the back of our latest commodity price deck revisions.
  • We are wary of potential borrowing base cuts as banks revisit their own price decks.
  • Although liquidity seems adequate and the company has no upcoming debt maturities, we expect covenant headroom will tighten, and we forecast cash outflows in 2020 and possibly 2021.
  • We lowered our issuer credit rating on Encino to 'B-' from 'B+'. We also lowered our issue-level rating on the company's second-lien term loan due 2025 to 'B' from 'BB'. We revised the recovery rating to '2', reflecting our expectation of a substantial (70%-90%, rounded estimate: 80%) recovery in the event of a payment default.
  • The negative outlook reflects our expectation that Encino's cash outflows over the next 12 months, along with potential borrowing base revisions, could put pressure on liquidity with almost half of the company's RBL facility already encumbered.
NEW YORK (S&P Global Ratings) March 26, 2020—S&P Global Ratings today took the above rating actions. The downgrade on Encino Acquisition Partners reflects substantially weaker credit metrics, including funds from operations (FFO) to debt well below our prior outlook trigger of 30%, with average debt to EBITDA projected to exceed 3.5x--coming within a turn of the 4x maximum leverage covenant under the credit agreement. We also expect Encino will outspend internally generated cash flow this year, which could strain liquidity because almost 50% of the $1.05 billion borrowing base is already encumbered by outstanding borrowings and letters of credit. Given recent market conditions, we believe lenders may take a more conservative stance during upcoming redetermination cycles, which would amplify credit risk. Notwithstanding the aforementioned factors, Encino is well-hedged across each of its production streams for 2020 and into 2021, and it should benefit from its firm transportation contracts. The company has approximately 80% of expected oil and gas production hedged in 2020 with over 65% hedged in 2021. Likewise, Encino's lack of near-term debt maturities (its credit facility expires in 2023 and its second-lien term loan matures in 2025) provides a longer runway relative to peers.
The negative outlook reflects our expectation that Encino's cash outflows over the next 12 months, along with potential borrowing base revisions, could put pressure on liquidity with almost half of the company's RBL facility already encumbered.
We could lower the rating if liquidity deteriorates, if we believe the capital structure is no longer sustainable, or if we believe there is a significant possibility of a debt exchange that we could view as distressed.
We could revise our outlook on Encino to stable if the company materially reduces revolver borrowings and maintains an FFO-to-debt comfortably above 20%. We believe this scenario could occur if commodity prices rebound and Encino generates sustained free cash flow.
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