(Fitch, 3.Feb.2021) — Fitch Ratings has assigned a ‘BB’/’RR1’ to CITGO Petroleum Corporation’s (Opco) $650mn senior secured 2026 notes. Proceeds from the notes, along with cash on hand, will be used to repay CITGO Petroleum’s 6.25% secured notes due August 2022 and associated fees.
The new notes will rank pari passu with other Opco debt and are secured by a first priority lien on CITGO’s three refineries (Lake Charles, Lemont, and Corpus Christi), its inventories, accounts receivables (excluding those pledged for specific carve-outs including the company’s A/R Securitization facility) and capital stock. Covenants are substantially similar to the company’s existing 2025 notes and include a change in control triggering event at 101, an equity clawback, and R/P basket restrictions.
CITGO’s ratings are supported by its high-quality refining assets, significant feedstock flexibility, modest capex requirements, prospects for a vaccine-led recovery in 2H21; and the industry rationalization of around 1.8 million bpd in excess refining capacity to date, which should help rebalance supply and demand.
Rating concerns are material and include market access issues linked to Petroleos de Venezuela’s (PDVSA) legacy ownership of CITGO; the deep deterioration in pandemic-linked demand seen in 2020 and the risks of a delayed recovery in 2021; medium term risks around structural changes in transport fuel demand for commuters and business travelers, and liquidity impacts.
The Negative Outlook could be revised if conditions normalize and liquidity is not materially compromised.
KEY RATING DRIVERS
Coronavirus Impacts: Although the industry has partly recovered from the deep trough conditions seen at the onset of the pandemic, the pandemic continues to have a lingering negative impact on utilization rates across the refining industry, which as of mid-January, were still running about 6 full percentage points below levels seen last year. The recovery in refined product demand has also been uneven. While distillate demand is up slightly, gasoline demand is still down around 11% yoy, and jet fuel around 20%-25% yoy, according to recent EIA data. Compression in key crack spreads has also reduced industry profitability.
Weak 2020, but Stronger 2H21: CITGO will experience material negative FCF in 2020, driven by pandemic impacts, substantial scheduled down time at both the Lake Charles and Lemont refineries, and unplanned downtime and repair expense at Lake Charles due to hurricane activity. Fitch anticipates a significant recovery in 2H21, but notes the speed of the recovery is subject to any slowdowns in vaccine campaigns, and any unfavorable structural changes in commuter trends (working from home and increased remote business meetings).
Covenant Waiver: At the end of 2020, CITGO received a waiver to increase its net debt-to-capitalization financial ratio from a maximum of 60% to 70%, effective until Q1 of 2022. The waiver creates additional headroom in the event the pandemic downturn is prolonged. Fitch notes that the company did not apply for a waiver for covenants which govern distributions up to CITGO Holdco, which still requires a positive dividend basket, maximum net debt to cap of 55% and minimum of $500mn in liquidity before distributions can be made. Holdco has enough liquidity to service its debt without any additional dividends from CITGO Petroleum until at least July 2022, but it could become an issue thereafter absent an additional waiver.
Improved Governance: In line with U.S. sanctions, CITGO severed all relationships with its PDVSA-appointed board and a new board was installed by the Guaido-led faction of Venezuela. Operationally, CITGO has ceased all financial and operational interactions with PDVSA. Challenges remain despite these improvements, including ongoing attempts by Venezuela to regain control of CITGO, although Fitch notes recent court rulings have been in favor of the Guaido-appointed board.
Access to Capital: The legacy effects of PDVSA ownership remains a key overhang on the issuer in terms of capital market access. In 2019, CITGO had to replace revolver liquidity with a drawn term loan, given bank concerns about Office of Foreign Assets Control sanctions against Venezuelan entities. Fitch believes CITGO has access to a capital pool that is deep but narrow.
Lower Change of Control Risks: The financial weakness of parent PDVSA means there are several paths that could trigger a change of control clause in CITGO’s debt. CITGO replaced earlier language with a more benign, two trigger tests: less than majority ownership by PDVSA and a related failure by rating agencies to affirm ratings within 90 days. Fitch believes there is a lower probability this test is triggered for several reasons, including: a longer 90-day period to complete a refinancing; and an expected improvement in CITGO’s credit profile under nearly any owner besides PDVSA, which limits bondholder incentives to tender. All of CITGO’s drawn debt, including the new proposed 2026 notes issuance, contains this double trigger language.
Parent-Subsidiary Linkage: Fitch rates the IDR of Holdco two notches below that of its stronger subsidiary, Opco. The notching differential stems from the significant legal and structural separations between the two, primarily the strong covenant protections for Opco’s debt, which limits the ability of the direct parent to dilute its credit quality. Key covenants include limitations on guarantees to affiliates, restrictions on dividends, asset sales and restrictions on the incurrence of additional indebtedness. Opco debt has no guarantees or cross-default provisions related to HoldCo debt.
HoldCo: Ratings for HoldCo reflect its structural subordination to OpCo and its reliance on OpCo to provide dividends to cover its significant debt service requirements. Dividends from OpCo provide the majority of debt service capacity at HoldCo and are driven by refining economics and the restricted payments basket. HoldCo’s pledged security includes approximately $40mn-$60mn in EBITDA from midstream assets available for interest payments. These logistics assets are pledged as collateral under the HoldCo debt package.
ESG Influence: CITGO has an Environmental, Social and Corporate Governance (ESG) Relevance Score of ‘4’ under Environmental Factors which reflects its material exposure to extreme weather events (hurricanes), which periodically lead to extended shutdowns. Two out of three of CITGO’s refineries are located on the Gulf Coast, including the largest, Lake Charles at 425,000 barrels per day (bpd).
CITGO also has a Score of ‘4’ under Governance Factors related to the effects the legacy PDVSA ownership issues still have on the issuer despite the transition CITGO made to being run by a U.S.-approved board. The risk centers around contagion through change of control clauses associated with a PDVSA default and the overhang legacy ownership creates in terms of capital markets access. Both factors have negative impacts on the credit profile and are relevant to the rating in conjunction with other factors.
DERIVATION SUMMARY
At 769,000 bpd day of crude refining capacity, CITGO is smaller than peer refiners such as Marathon Petroleum Corporation (BBB/Negative) at 3.0 million bpd, Valero Energy Corporation (BBB/Negative) at 2.6 million bpd, and PBF Holding (B+/Negative) at 1.04 million bpd, but is larger than peers HollyFrontier Corporation (BBB-/Negative) at 405,000 bpd and CVR Refining (BB-/Negative) at 206,500 bpd.
CITGO lacks the earnings diversification from ancillary businesses seen at a number of peers in areas such as logistics master limited partnerships, chemicals, renewables or retail. However, CITGO’s core refining asset profile is strong, given the high complexity of its refineries, which allows it to process a large amount of discounted heavy crudes and shale crudes, both of which have historically boosted profitability but currently offer limited uplift given the pandemic. Legacy PDVSA ownership issues still remain an overhang on the issuer through change of control contagion and market access issues.
KEY ASSUMPTIONS
Fitch’s Key Assumptions Within Its Rating Case for the Issuer Include:
–West Texas Intermediate oil prices of $42/bbl in 2021, $47/bbl in 2022 and $50/bbl in 2023 and the long run;
–Gross margins and refinery utilization drop sharply in 2020 and recover over the remainder of the forecast;
–Capex of $257mn in 2021, which rises slowly across the remainder of the forecast in line with recovering fundamentals;
–CITGO experiences continued weakness in operating results in 1H2021 before seeing a vaccine led recovery in refined product fundamentals in the second half of the year, and sees continued gradual improvements thereafter.
KEY RECOVERY RATING ASSUMPTIONS
The recovery analysis assumes that CITGO Corporation would be reorganized as a going-concern in bankruptcy rather than liquidated.
Fitch has assumed a 10% administrative claim.
Going-Concern (GC) Approach
The GC EBITDA of $1.16bn estimate reflects Fitch’s view of a sustainable, post-reorganization EBITDA level upon which Fitch bases the enterprise valuation (EV). This value reflects the potential for narrower crude spreads on a mid-cycle basis due to structural changes in the market.
An EV multiple of 5.0x was applied to the GC EBITDA to calculate a post-reorganization EV of $5.78bn. This multiple is below the median 5.7x exit multiple for energy in Fitch’s Energy, Power and Commodities Bankruptcy Enterprise Value and Creditor Recoveries (Fitch Case Studies – August 2020), but is also above the multiple for the only refining-related bankruptcy contained in that study, Philadelphia Energy Solutions.
Liquidation Approach
The liquidation estimate reflects Fitch’s view of the value of balance sheet assets that can be realized in sale or liquidation processes conducted during a bankruptcy or insolvency proceeding and distributed to creditors.
For liquidation value, Fitch used an 80% advance rate for the company’s inventories since crude and refined products are standardized and easily re-sellable in a liquid market to peer refiners, traders or wholesalers. Fitch also assigned relatively light discounts to CITGO’s net PP&E, based on historical refining transactions, and A/R. These items summed to a total liquidation value of $4.04bn.
The maximum of these two approaches was the going concern approach of $5.78bn.
A standard waterfall approach was then applied. Subtracting 10% for administrative claims resulted in an adjusted EV of $5.2bn, which resulted in a three-notch recovery (RR1) for all of CITGO Petroleum’s secured instruments (including the new notes), which are pari passu.
A residual value of approximately $2.24bn remained after this exercise. This was applied in a second waterfall at CITGO Holdco, whose debt is subordinated to that of Opco. The $2.24bn was added to approximately $400mn in going concern value associated with the Midstream assets ($50mn in assumed run-rate midstream using an 8x multiple), as well as $179mn in restricted cash, which was escrowed in a debt service reserve account for the benefit of secured Holdco debt, along with A/R. This resulted in total initial value at Holdco of approximately $2.82bn. No administrative claims were deducted in the second waterfall. Holdco secured debt also recovered at the ‘RR1’ level.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
CITGO Petroleum
–Sustained improvement in the refined product market, marked by recovering utilization and crack spreads;
–Improved market access;
–Mid-cycle lease-adjusted FFO-gross leverage below approximately 4.3x;
–Mid-cycle debt/EBITDA below 3.0x.
CITGO Holding
–Sustained improvement in the refined product market, marked by recovering utilization and crack spreads;
–Improved market access;
–Mid-cycle lease-adjusted FFO-gross leverage below approximately 6.0x;
–Mid-cycle debt/EBITDA below 4.8x.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
CITGO Petroleum
–Prolonged dislocation in refined product market, leading to sustained weakness in metrics and impaired liquidity;
–Deterioration in market access;
–Mid-cycle lease-adjusted FFO-gross leverage above approximately 5.5x;
–Mid-cycle debt/EBITDA above 4.1x;
–Weakening or elimination of key covenant protections in the CITGO senior secured debt documents.
CITGO Holding
–Deterioration in market access;
–Mid-cycle lease-adjusted FFO-gross leverage approaching 7.5x;
–Mid-cycle debt/EBITDA approaching 6.5x;
–Weakening or elimination of key covenant protections in CITGO Holding senior secured debt documents.
BEST/WORST CASE RATING SCENARIO
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from ‘AAA’ to ‘D’. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
LIQUIDITY AND DEBT STRUCTURE
Adequate Liquidity: Opco’s liquidity, as of YE 2020, comprised $1.01bn in cash, as well as an untapped two-year $250mn A/R Securitization facility, for total liquidity of $1.26bn, versus liquidity of $971mn at Sept. 30, 2020. The majority of OpCo’s cash is from proceeds of a $1.2bn term loan, which was issued in 2019 as replacement liquidity for a terminated senior secured revolver and accounts receivable securitization facility. CITGO maintains this liquidity on the balance sheet to handle working capital swings and for other cyclical needs. CITGO also has $290mn in industrial revenue bonds in treasury that could be remarketed, assuming supportive market conditions. Following the repayment of the 2022 6.25% term loan, the next material maturity due at the Opco level is the company’s $1.08bn term loan in 2024.
DATE OF RELEVANT COMMITTEE
10 April 2020
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG CONSIDERATIONS
CITGO has an ESG Relevance Score of ‘4’ for Exposure to Environmental Impacts due to the material exposure that Gulf Coast refiners have to extreme weather events (hurricanes), which has a negative impact on the credit profile, and is relevant to the ratings in conjunction with other factors.
CITGO also has an ESG Relevance Score of ‘4’ for Complexity, Transparency, and Related-Party Transactions relating to the impact the legacy PDVSA ownership structure has on the issuer, which has a negative impact on the credit profile, and is relevant to the ratings in conjunction with other factors.
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of ‘3’. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch’s ESG Relevance Scores, visit www.fitchratings.com/esg.
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