$750 million rated debt affected
New York, November 28, 2012 -- Moody's Investors Service affirmed EXCO Resources, Inc.'s (XCO) Corporate Family Rating (CFR) and its Probability of Default Rating (PDR) at B1, and affirmed its B3 senior unsecured notes rating. The rating affirmation follows XCO's announcement that it will drop certain of its E&P assets into a newly formed partnership (MLP) to be jointly owned with the Harbinger Group, Inc. (HRG, B3 negative), using drop-down proceeds for debt reduction. The outlook is stable.
"While ongoing spending declines are now better aligned with XCO's reduced cash flow, a function of its exposure to weak US natural gas markets, the impact on reserves and production growth will be negative," commented Andrew Brooks, Moody's Vice President. "However, the proposed MLP transaction will allow XCO to participate in future growth at this entity while raising much needed funds for liquidity and debt reduction at the XCO level."
Ratings Affirmed: . Corporate Family Rating, B1 . Probability of Default Rating, B1
. US $750 Million Senior Unsecured Notes due 2018, B3 (LGD5, 83%)
. Speculative Grade Liquidity Rating, SGL-3
XCO's B1 CFR reflects its significant exposure to price weakness in the US natural gas market, and resultant weak cash margins and pressured liquidity countered by the efforts currently underway to reduce debt through asset sales and spending reductions. XCO's strong growth in production and reserves in 2010 and 2011 was accompanied by large increases in debt outstanding, with funding needs augmented by proceeds from the sale of non-core assets, as well as up-front payments and drilling carry from affiliates of BG Energy Holdings Ltd (BG Group, A2 negative), its upstream joint upstream partner in its core Haynesville and Marcellus acreage. Reflecting strong production growth, up 63% in 2011, relative debt leverage has remained at modest levels compared to XCO's B1 rated peers. However, with drilling carry effectively used up, declining cash flow has prompted XCO to cut spending and drop its rig count, with production levels flattening and likely to decline into 2013. Weak natural gas prices are expected to continue to pressure XCO's cash flow and margins, prompting the company to focus on debt reduction and liquidity enhancement, which is supportive of the rating.
On November 5, XCO announced that it would contribute certain of its conventional E&P assets into a newly formed MLP whose limited partnership (LP) interests would be owned 73.5% by HRG and 24.5% by XCO. The 2% general partner (GP) interest will be owned equally between HRG and XCO. In exchange for its asset contribution, XCO will receive the LP interest and cash proceeds approximating $580 million, $225 million of which will be funded by a new proposed $400 million revolving credit to be entered into by the MLP. XCO will use the cash proceeds to reduce outstandings under its revolving credit, which at September 30 totaled $1.1 billion. Production associated with the divested assets approximates 100 Mmcfe per day (about 16.7 mBoe per day), or the equivalent of about 20% of total third quarter production, and roughly 40% of its proved reserves. In addition to cash distributions received through its ownership of the LP units, holding incentive distribution rights (IDRs) through its GP interest will allow XCO to participate in the MLP's future growth. The transaction will have an effective date as of July 1, 2012, and is expected to close in early 2013. The debt reduction provided by this transaction is an important factor in Moody's affirmation of the rating.
XCO's SGL-3 Speculative Grade Liquidity rating reflects an adequate liquidity position through 2013, substantially assisted by the MLP proceeds, and spending reductions. In April 2012, the borrowing base under XCO's secured borrowing base revolving credit facility was reduced to $1.4 billion from $1.6 billion following its semi-annual redetermination, and it was redetermined downward again on October 30 to $1.3 billion. The company had $140 million of balance sheet cash at September 30, giving it pro forma liquidity of approximately $326 million. Following completion of the MLP transaction, XCO's borrowing base will be reduced to $900 million under which on a pro forma basis, borrowings will be reduced to approximately $510 million, resulting in total liquidity improving to over $500 million. With the company budgeting to operate within 2013 cash flow (in fact having already achieved that balance over the first nine-months of 2012), this liquidity cushion should prove adequate. Moreover, a possible monetization of XCO's 50% stake in its midstream gas gathering joint venture with BG Group could add additional asset sale proceeds for debt reduction. XCO's credit facility matures in April 2016. In April 2012, revolving credit lenders provided covenant relief, increasing XCO's debt to EBITDAX covenant to 4.5x from 4.0x. We expect that XCO will remain in compliance with its financial covenants through 2013.
The rating outlook is stable reflecting the actions XCO is undertaking to cut costs and reduce debt to more appropriately align its spending with cash flow. We could downgrade the ratings should liquidity fall below $200 million, or if debt leverage approaches $14 per Boe of proved developed reserves or $25,000 per Boe of average daily production. Additionally, if the MLP transaction fails to close as proposed, the rating would likely be downgraded. A rating upgrade in the near term is unlikely. However, should XCO restore growth in its reserves and production while reducing debt leverage to $8 per Boe of proved developed reserves and $15,000 per Boe of average daily production, and increase cash margins sufficient to sustain a 1.5x leverage full-cycle ratio, an upgrade could be considered.
The B3 rating on its senior unsecured notes reflects both the overall probability of default of XCO, to which Moody's assigns a PDR of B1, and a loss given default of LGD5 (83%). XCO's senior unsecured notes are subordinate to its $1.3 billion secured borrowing base revolving credit's potential priority claim to the company's assets. The size of the potential senior secured claims relative to XCO's outstanding senior unsecured notes results in the notes being rated two notches below the B1 CFR under Moody's Loss Given Default Methodology.
The principal methodology used in rating EXCO was the Global Independent Exploration and Production Industry Methodology published in December 2011. Other methodologies used include Loss Given Default for Speculative-Grade Non-Financial Companies in the U.S., Canada and EMEA published in June 2009. Please see the Credit Policy page on www.moodys.com for a copy of these methodologies.
EXCO Resources, Inc. is an independent exploration and production company headquartered in Dallas, Texas.
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Andrew Brooks Vice President - Senior Analyst Corporate Finance Group Moody'sInvestors Service, Inc.250 Greenwich StreetNew York, NY 10007 U.S.A. JOURNALISTS: 212-553-0376 SUBSCRIBERS: 212-553-1653Steven Wood MD - Corporate Finance Corporate Finance Group JOURNALISTS: 212-553-0376 SUBSCRIBERS: 212-553-1653 Releasing Office: Moody's Investors Service, Inc.250 Greenwich StreetNew York, NY 10007 U.S.A. JOURNALISTS: 212-553-0376 SUBSCRIBERS: 212-553-1653(C) 2012 Moody's Investors Service, Inc. and/or its licensors and affiliates (collectively, "MOODY'S"). All rights reserved.
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