By Brad Bell, CFA
& Mark Sadeghian, CFA
CHICAGO -- Fitch Ratings has downgraded the Issuer Default Rating (IDR) of CITGO Holding, Inc. (Holdco) to 'CCC' from 'B-'. Fitch has also placed the ratings for Holdco and CITGO Petroleum Corporation (Citgo, 'B' IDR) on Rating Watch Negative.
The downgrade at Holdco and its placement on Rating Watch Negative reflect increased refinancing risk linked to the 2018 Holdco Term Loan. The Rating Watch also reflects potential contagion effects from ultimate parent Petroleos de Venezuela (PDVSA) on both CITGO entities. Recent associated headline risks include the impact of U.S. sanctions on Venezuela; the arrests of a number of CITGO executives in Venezuela on corruption charges; and payment defaults by PDVSA. The 2018 HoldCo Term Loan ($611 million left remaining at Sept. 30) is now current and comes due May 12, 2018. Successful refinancing of the 2018 TL and a reduction in contagion-associated risks could result in a removal of the Rating Watch Negative and an upgrade to 'B-' at CITGO Holding.
CITGO's ratings are supported by quality refining assets and good geographic positioning, strong financial results and credit metrics for the rating, and minimal capex requirements which help to support the dividend program to CITGO Holding. Fitch believes the key risks to CITGO creditors relate to refinance risks and potential change of control issues, which could be driven by further defaults by parent PDVSA or the ultimate outcome of pending litigation and arbitral awards against PDVSA. Ultimately, a change of control has the potential to relieve significant rating constraints on the CITGO structure. Mitigation of parent company risk would likely be a positive development from a CITGO lenders perspective, implying a greater likelihood of obtaining change of control consents. Fitch believes that the liquidity and refinancing risks following a change of control are manageable given underlying CITGO credit fundamentals and that these risks are embedded in current CITGO ratings. KEY RATING DRIVERS
Refinance Risks: CITGO Holding's 2018 Term Loan comes due May 12, 2018. Total remaining balance as of Q3 on the term loan was $611 million. Cash balances available to be netted against the Holdco term loan on a pro forma basis totalled approximately $273 million ($145 million in unrestricted pro forma cash, $87 million in debt service cash associated with the term loan, and an excess of $41 million in debt service reserves that have built associated with the Holdco bonds. As a result the net TL that required refinancing at Sept. 30, 2017 stood at just $338 million. Fitch expects cash will continue to build at CITGO due to favorable refining conditions and the impact of sanctions. As a result, Fitch estimates that the net TL debt at the Holdco level will continue to decline moderately.. Fitch believes that the most realistic option for refinancing is an extension, rather than a comprehensive refinancing of all of CITGO's debt, which is what the company has done in the past in more normal environments. At the same time, the current environment is very challenging for the company to refinance in given concerns about the parent.
Sanctions Impact Manageable: The impact of U.S. sanctions on Venezuela has been material but manageable. On an operations level, crude purchases from Venezuela by CITGO are permitted. CITGO continues to run its refining system with a majority of non-Venezuelan crudes, including U.S., Canadian heavy, West African, and other South American crudes. If Venezuelan imports were to be blocked, Fitch believes CITGO could find adequate third party supply with limited economic impact.
U.S. sanctions also allow CITGO Petroleum, subject to a restricted payments basket, to pay dividends up to CITGO Holding to service the debt at that level. This is done through a license from the U.S. Treasury that needs to be renewed annually. However, CITGO Holding cannot currently pay dividends up to PDV Holding/PDVSA, due to sanctions. Fitch views this as ultimately positive for HoldCo as it serves to trap cash at the entity with the most refinancing risk. Despite the reported arrests of several CITGO executives in Venezuela on corruption charges, Fitch believes the company's ability to negotiate a refinancing deal remains intact as the board retains a quorum.
Change of Control Risks: In the case of a default on the PDVSA senior notes due 2020, foreclosure on the equity collateral (Citgo Holding stock) would likely trigger change of control provisions in existing Citgo debt. If unable to obtain sufficient consents from lenders, Citgo would be obligated to make an offer to repurchase outstanding senior notes at 101. The company would have a 90-day repurchase window (complete offer within 30 days, complete transaction 60 days subsequent), providing some time to refinance the notes or otherwise raise sufficient liquidity. Citgo Holding's term loan would be required to be repaid within three days of a change in control, absent consents. A change in control would constitute an event of default under Citgo Petroleum's revolving credit agreement and term loan. Lenders would have the option to accelerate the loans or provide change of control consent.
While Fitch believes Citgo would likely have the ability to either obtain lender consents or refinance the existing debt package, external events including capital market shocks or difficulty reaching consensus amongst a diverse bondholder group could impair the company's ability to do so within the applicable repurchase windows. Recent events involving PDVSA also serve to complicate the situation, and could influence investors' perceptions of the debt.
PDVSA Ownership Key Rating Constraint: There is a relatively strong operational linkage between CITGO and PDVSA (long-term foreign and local currency IDRs 'RD'). This relationship is evidenced by a history of use of CITGO as a source of dividends to its parent, frequent placement of PDVSA personnel into CITGO executive positions, control of CITGO's board by its parent, and existence of a crude oil supply agreement. However, there are important legal and structural separations between the two entities.
CITGO is a Delaware corporation with U.S. domiciled assets and is separated from PDVSA by two Delaware C-Corps, CITGO Holding, Inc., and PDV Holding Inc. The most important factor justifying the rating notching between CITGO and PDVSA is the strong covenant protections in CITGO's secured debt, which limit the ability of the parent to dilute CITGO's credit quality. Key covenants include limitations on guarantees to affiliates, restrictions on dividends to CITGO Holding and PDVSA, asset sales, and incurrence of additional indebtedness. CITGO debt has no guarantees or cross-default provisions related to PDVSA debt.
Good Refining Assets and Positioning: CITGO owns and operates three large, high-quality refineries, providing sufficient economies of scale to compete with larger tier-1 refiners. Positioning in the Midwest and Gulf Coast provides access to a variety of crudes, including U.S. sweet crudes, Canadian heavies, and heavy sour imports at the Gulf. CITGO's refineries have above-average complexity, including substantial coking capacity, allowing for conversion of discounted heavier and sour crudes into higher-value products. Coking capacity in particular will be important for sustaining profitability now that the U.S. crude export ban has been lifted. CITGO's position on the Gulf allows favorable access to export markets, which is an important component in maintaining competitive gross margins relative to peers.
CITGO HOLDING: Debt Supported by CITGO Petroleum Cash Flow: Ratings for CITGO Holding are two notches below CITGO Petroleum, reflecting the heightened refinance/probability of default risk, structural subordination and a reliance on CITGO Petroleum to provide dividends for debt service. Dividends from CITGO Petroleum will provide the majority of debt service capacity at CITGO Holding, and will be driven primarily by refining economics and the restricted payments basket. As part of the 2015 financing, CITGO Holding purchased $750 million in logistics assets from CITGO Petroleum, which provide approximately $45 million to $50 million in EBITDA at CITGO Holding available for interest payments. These logistics assets are pledged as collateral under the CITGO Holding debt package.DERIVATION SUMMARY
At 749 thousand bbl/d day of refining capacity, CITGO is smaller than investment grade refiners MPC (1.8 million bbl/d), VLO (2.7 million bbl/d), PSX (2.1 million bbl/d), and Andeavor (1.2 million bbl/d). However, given CITGO's size, asset positioning, and cash flow potential, Fitch informally estimates that, on a stand-alone basis with no parental rating constraints, that CITGO could be rated significantly higher than its current rating. Parent-subsidiary linkage and ties with PDVSA are the key constraints on the current rating.KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer include:
--No major capital projects over the forecast horizon with annual CITGO capex of $350 million;
--Regional crack spreads decline to mean inflation-adjusted levels over the forecast horizon;
--Long-run refining gross margin of $9-$10/bbl;
--No material increases in corporate SG&A and refining opex/bbl;
--CITGO Petroleum pays approximately 100% of net income to CITGO Holding.RATING SENSITIVITIES
Future Developments That May, Individually or Collectively, Lead to Positive Rating Action
--Change in ownership to a higher-rated parent, or changes leading to a stand-alone credit analysis;
--Improved ratings at PDVSA given the explicit ratings linkage;
--Stronger structural separations between CITGO and PDVSA leading to a wider notching rationale between the two.
--Change in ownership to a higher-rated parent, or structural changes leading to a stand-alone credit analysis;
--Successful refinance of the 2018 TL.
Future Developments That May, Individually or Collectively, Lead to Negative Rating Action
--Weakening or elimination of key covenant protections contained in the CITGO senior secured debt documents through refinancing or other means;
--Inability to refinance debt following a change-of-control, absent lender consents or for other reasons;
--A sustained operational problem at one or more refineries leading to impaired cash flow forecasts and credit metrics.
--Inability to refinance 2018 Term Loan;
-Weakening or elimination of key covenant protections contained in CITGO Holding senior secured debt through refinancing or other means;
--Operational problems or weakening long-run fundamentals at CITGO that negatively affect the dividend stream to CITGO Holding.LIQUIDITY
CITGO Petroleum At Sept. 30, 2017 CITGO Petroleum had approximately $1.2 billion in available liquidity, consisting of $895 million in revolver availability, $229 million in cash and $70 million in availability on the accounts receivable facility. Fitch believes this will be adequate for near-term liquidity requirements in the ordinary course of business, which would consist primarily of working capital needs following another large move in crude or product prices. Fitch expects that capex, dividends and other calls on liquidity will be funded with operating cash flow. CITGO Petroleum has no maturities until the term loan B due in 2021, with remaining principle of $632 million.
CITGO Holding CITGO Holding's secured term loan B is due in 2018, with a remaining principle of approximately $611 million. On a consolidated basis, CITGO Holding reported $471 million in cash at Sept. 30, 2017. On a standalone basis, CITGO Holding reported $242 million in unrestricted cash. The $242 million in unrestricted cash partly reflects that normal Q3 bond interest and term loan amortization payments did not need to go out Sept. 30 due to a holiday and instead went out Oct. 2. Pro forma if those payments had gone out on Sept. 30, unrestricted cash would have been approximately $145 million. When added to debt service reserve accounts associated with the term loan of $87 million, and an excess of $41 million in debt service reserves that had built associated with the Holdco bonds, total available cash that could be netted against the Holdco TL was approximately $273 million.
If a change of control occurs, CITGO Holding would be required to repay its senior secured term loan B in full within three business days following such change of control and to make an offer to purchase its 10.75% senior secured notes. Additionally, CITGO would be required to make an offer to purchase its 6.25% senior secured notes.
STRONG RECOVERY: For CITGO, Fitch assumed $1 billion in going concern EBITDA at the OpCo based upon Fitch's base case forecast and outlook for mid-cycle crack spreads. Fitch then applied a 4.4x multiple based upon adjusted industry comps, which resulted in initial going concern value of $4.4 billion. The 4.4x multiple reflects the volatility of refining profits and the tendency of the industry to produce positive free cash flow in many environments.
The 4.4x multiple also reflects a downward adjustment to reflect the fact that CITGO's parent has chosen to run its assets over the last several years to maximize dividend payments to its owner, a policy that is likely to result in incremental capex and investment requirements by CITGO or a third party operator.
Fitch then subtracted 10% for administrative claims, resulting in adjusted EV of $3.96 billion.
This resulted in 100% coverage (RR1) for the secured revolver, TL and notes at CITGO Petroleum. A residual value of $1.67 billion remained after this exercise.
This was applied to a second waterfall at CITGO Holdco, whose debt is subordinated to that of CITGO Petroleum insofar as dividends after debt service at Petroleum are used to service debt at Holdco.
The $1.67 billion was added to $400 million in GC value associated with Midstream assets held at Holdco for total initial value of $2.07 billion. After deductions for administrative claims, the Holdco Term Loan and bonds recovered at the 'RR2' level (88%). FULL LIST OF RATING ACTIONS
Fitch has placed the following ratings on Rating Watch Negative:
Citgo Petroleum Corp.
--Long-Term IDR at 'B';
--Senior secured credit facility at 'BB/RR1';
--Senior secured term loans at 'BB/RR1';
--Senior secured notes at 'BB/RR1';
--Fixed-rate industrial revenue bonds at 'BB/RR1'.
Citgo Holding, Inc.
--Long-Term IDR from 'B-' to 'CCC';
--Senior secured term loans from 'B+'/'RR2' to 'B-'/'RR2';
--Senior secured notes from 'B+'/'RR2' to 'B-'/'RR2'.