(The following was released by the rating agency)
-- Coffeyville Resources LLC's indirect subsidiary CVR Refining LLC is issuing $500 million of second lien notes initially guaranteed by Coffeyville Resources. The partnership will use proceeds to redeem Coffeyville's $447 million of first lien notes due 2015.
-- With proceeds from an expected IPO of CVR Refining L.P. as a variable master limited partnership (MLP), Coffeyville will redeem its $223 million second-lien notes. We expect that CVR Refining LLC will then become a subsidiary of the MLP, its $500 million notes will become unsecured debt, and the Coffeyville guarantee will fall away.
-- We are revising Coffeyville Resources' outlook to stable, affirming our ratings on its first and second liens, and assigning a 'B+' issue rating to the new $500 million notes, reflecting our expectation of the issuance's final credit quality as unsecured debt at the MLP.
On Oct. 9, 2012, Standard & Poor's Ratings Services affirmed its 'B+' corporate credit rating on Coffeyville Resources LLC, and we revised the outlook on the rating to stable from developing. We also affirmed our 'BB' rating on its $447 million first-lien senior secured notes, our 'B+' rating on its $223 million second-lien senior secured notes, and we assigned a 'B+' issue rating to CVR Refining LLC's $500 million senior secured second-lien notes, which Coffeyville initially guarantees. At the same time, we revised our recovery rating on Coffeyville's second-lien senior secured notes to '3' from '4', indicating a higher expectation of recovery (50% to 70%) to lenders in a payment default, and we assigned a '3' recovery rating to the new CVR Refining LLC notes.
We view the refinancing and restructuring of the refining business as a variable MLP as neutral to moderately positive for credit, and our analysis considers two distinct phases. After Coffeyville redeems its first-lien notes with proceeds from CVR Refining LLC's $500 million issuance and before the CVR Refining L.P. IPO, long-term debt increases by $53 million. But, because the two tranches of second-lien debt are secured on a pari passu basis, lenders will enjoy stronger recovery prospects because there is no priority first-lien debt. For this period, the issue-level credit profile will moderately improve.
In the second phase, Coffeyville will issue an IPO for CVR Refining L.P. as a variable MLP, drop the Coffeyville and Wynnewood refineries and its logistics assets down to the MLP, and use some proceeds to redeem its $223 million second-lien notes. CVR Refining LLC will then become a subsidiary of the MLP and its $500 million notes will become unsecured debt. While we view the significant debt reduction positively, we believe MLP distribution policies can weigh on financial risk because unitholders will expect quarterly distributions from available cash flow. In general, we believe this leaves an MLP more vulnerable to liquidity strains than a corporate issuer. MLPs rely much more than corporations on outside sources of capital to fund growth spending, and are more vulnerable to frozen capital markets. Lenders to the $500 million notes will also become unsecured lenders with no security interests, and will not benefit from the cash flows and diversity that the fertilizer business currently provides at the Coffeyville level. We also expect that CVR Refining LLC will enter into a $150 million senior unsecured credit facility that will reduce recovery prospects if a default occurs. Because we believe management will work to create a final structure similar to this expectation, we base our second-lien debt ratings on the second phase and therefore do not notch up the issue ratings, despite a modestly improved credit profile over the short term.
We largely base Coffeyville's current "weak" business risk and "significant" financial risk profiles on the refining sector's volatility, and Coffeyville's concentrated asset base. Although we expect Coffeyville's refining business will continue to earn high margins with average "crack spreads" (the price differential between crude oil and the refined product) in the mid-teens through late 2013 because of discounted crude oil stocks in the PADD-II region, pipeline developments are likely to compress future discounts. We expect the Enbridge-Enterprise Seaway pipeline reversal will continue to ramp up from 150,000 barrels per day (bpd) to about 400,000 bpd by early 2013, and the Keystone XL pipeline extension, if and when it is complete, would provide additional take-away capacity to relieve oversupply in PADD-II. Furthermore, we believe Coffeyville still remains exposed to unpredictable cyclical swings in long-term commodity pricing. We do not expect refined product demand to strengthen materially, assuming continued motor vehicle fuel efficiency, sustained high prices, and a slow economic recovery.
Coffeyville's June 30, 2012, trailing 12-month debt to EBITDA was 1.2x, and we expect it to remain below 2x through 2013, even assuming that crude differentials and crack spreads moderate slightly. A sustained crude discount could help reduce the ratio further, as would the IPO and debt redemption, which would further reduce long-term debt. Compared with peers, the Coffeyville and Wynnewood refineries benefit from low operating costs per barrel. The company can also benefit from the 12.9 complexity score at Coffeyville and 9.3 score at Wynnewood by processing heavier or sourer crude slates when price differentials exist. Similarly, its PADD-II Group 3 locations can help when the market is undersupplied and refined products are at premium prices, although the basis has flipped in 2012 due, in our opinion, to excess production relative to local demand.
The ratings reflect the following strengths:
-- A significant West Texas Intermediate (WTI) pricing benchmark discount to Brent crude since early 2011 has increased refiners' profits in PADD-II;
-- Coffeyville's high-complexity refinery assets and pipeline connectivity allow it to take advantage of crude differentials to WTI and its PADD-II location can help product pricing if the region is short of product;
-- Management plans for significant debt reduction using IPO proceeds;
-- Diversification of cash flows in the current structure between the refining and fertilizer businesses and a competitive cost structure for the fertilizer business;
-- Gathering and storage assets that allow the project to lower its crude cost and take advantage of contango pricing; and
-- A crude supply intermediation agreement with Vitol at the refineries, which minimizes inventory costs and outsources hedging risk.
In our view, the following weaknesses partly offset the strengths:
-- Significant commodity and pricing volatility in the merchant refining and fertilizer business;
-- Although the Wynnewood acquisition added some diversity to the asset base, both refineries are in the PADD-II region and aresubject to similar geographic economics;
-- After the IPO of the MLP, lenders to the new debt will be unsecured with no security interests, and will not benefit from the Coffeyville guarantee or fertilizer business cash flows; and
-- We expect the new notes will become an obligation at the MLP structure, and we generally view MLP financial policy as more aggressive because of distribution policies that can reduce liquidity and increase reliance on capital market access for funding.
Our ratings currently consolidate Coffeyville's fertilizer partnership, CVR Partners L.P., which provides some additional cash flow diversity. CVR Refining LLC is an indirect wholly owned subsidiary of Coffeyville Resources LLC, a Sugarland, Texas-based independent oil refiner and fertilizer producer. Upon redemption of Coffeyville's $447 million in first-lien senior secured notes, we plan to withdraw our ratings on the issue. After CVR Refining L.P.'s IPO, the asset drop-down, and redemption of Coffeyville's $223 million second-lien notes, we expect that Coffeyville will have no debt and we will base our ratings for CVR Refining LLC's unsecured debt on the stand-alone CVR Refining L.P. entity.
As of June 30, 2012, Coffeyville had about $447 million of first-lien senior secured term notes outstanding and about $223 million of second-lien senior secured notes. It also had a $400 million asset-backed revolving credit facility, which we do not rate, with $53 million in letter of credit commitments and $347 million of availability. CVR Partners L.P., a master limited partnership with common units held 70/30 between Coffeyville and public holders owns the fertilizer business, Coffeyville Resources Nitrogen Fertilizers LLC (CRNF). CRNF has an additional $125 million term loan and an undrawn $25 million revolving credit facility that we include in our credit measures. Coffeyville also indirectly holds the noneconomic general partner interest.
Coffeyville Resources is a 185,000 bpd independent refiner and marketer of high-value transportation fuels, and a low-cost producer of ammonia and urea ammonium nitrate fertilizers. The company's petroleum segment consists of two refineries--the Coffeyville refinery in Kansas (115,000 bpd capacity) and the Wynnewood refinery in Oklahoma (70,000 bpd capacity). The adjacent fertilizer plant at Coffeyville produces an average 1,225 tons of ammonia daily and 2,025 tons of urea ammonium nitrate and, when natural gas prices are high, it enjoys cost advantages over natural gas-based fertilizer plants because it uses petroleum coke produced at the refinery rather than natural gas. We do not view revenue from the crude oil-gathering system, the asphalt, and refined fuels terminal facility, and the crude oil pipeline system as significant credit factors for Coffeyville. However, the gathering system does support the refineries' realized crude differential.
We currently view Coffeyville's liquidity as "strong", with about $1.2 billion of expected sources over the next year and significant cushion under its financial covenants. The company had a large cash position, totaling almost $693 million on a consolidated basis as of June 30, 2012, well in excess of expected operating requirements for the next year. Other liquidity sources include $347 million of availability under Coffeyville's $400 million asset-based loan facility, $25 million of CRNF credit, and about $500 million of funds from operations in the next 12 months under our assumptions. We estimate about $330 million of uses for the next year, including about $150 million of working capital requirements and $180 million in capital spending. However, moving to an MLP structure could significantly increase distributions and reduce Coffeyville's cash balance. Upon consummation of an IPO, we would review our liquidity assessment and could lower it at that time.
Our 'BB' issue-level rating and '1' recovery rating on Coffeyville's first-lien senior secured term notes indicates that we expect a very high recovery (90% to 100%) if a default occurs. Our 'B+' issue-level rating and '3' recovery rating on Coffeyville and CVR Refining LLC's second-lien senior secured term notes indicates that we expect a meaningful recovery (50% to 70%) if a default occurs. For more details on our analysis, please see our recovery report to be published shortly on RatingsDirect.
The stable outlook reflects Coffeyville's strong liquidity and our expectation of robust refining margins through 2013. However, we believe the planned MLP structure will reduce business diversity and is likely to increase risks in Coffeyville's financial profile, limiting its upgrade potential until a track record as an MLP is established. At that point, we could raise ratings if we think the company can maintain a debt to EBITDA ratio significantly below 2x. This could be achievable if we become convinced that the partnership will benefit from favorable crude and product differentials on a more permanent basis, or if it can reduce business risk by further diversifying its assets. We could lower the ratings if refining and fertilizer margins contract such that we expect sustained debt to EBITDA above 3.5x.
Related Criteria And Research
Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
Key Credit Factors: Criteria For Rating The Global Oil Refining Industry, Nov. 28, 2011
Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
Principles Of Credit Ratings, Feb. 16, 2011
2008 Corporate Ratings Criteria: Analytical Methodology, April 15, 2008
Ratings List Ratings Affirmed; Outlook Revised; Recovery Rating Revised To From Coffeyville Resources LLC Corporate credit rating B+/Stable/-- B+/Developing/-- 1st-lien sr secured notes BB Recovery rating 1 2nd-lien sr secured notes B+ Recovery rating 3 4 New Rating CVR Refining LLC $500 mil sr secd second-lien notes B+ Recovery rating 3
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