September 22, 2016 - 11:59 AM EDT
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Fitch Places CITGO's Ratings on Negative Watch

Fitch Ratings has placed the ratings of CITGO Petroleum and CITGO Holding on Rating Watch Negative following PDVSA's announced debt exchange offer. PDVSA (Long-Term Issuer Default Rating 'CCC') expects to issue new 8.5% sinking notes due 2022 under a voluntary exchange for two existing bonds: a 8.5% sinking bond with $2.05 billion principal payments due in November 2016 and November 2017 and a $3.0 billion 5.25% bond due in 2017. The exchange offer, if successful, has the potential to increase CITGO bondholders' exposure to PDVSA default risk through the use of 50.1% of CITGO Holding stock as collateral for the new PDVSA notes. Existing debt indentures at CITGO Petroleum and CITGO Holdings contain change of control provisions which could potentially be exercised if the new PDVSA notes default and there is foreclosure on collateral, namely the majority stake in CITGO Holdings. Fitch intends to resolve the Negative Watch following the expiration of the announced PDVSA exchange offer, which is scheduled for October 14. Potential changes to CITGO's ratings will be based on Fitch's assessment of changes in linkage between PDVSA and CITGO based on the final terms of any exchange or agreement, as well as the likelihood that triggering the change in control provision would heighten CITGO's probability of default.

KEY RATING DRIVERS

Taken together, the equity pledge and potential for PDVSA to default on the new notes increase refinancing risk for CITGO, as well as increase exposure to material events outside CITGO's control, namely the willingness and ability of PDVSA to meet debt service obligations. In the case of a PDVSA default on the new notes due 2020, foreclosure on the equity collateral would likely trigger change of control provisions in existing CITGO debt. If CITGO was unable to obtain sufficient consents from lenders, the company would be obligated to make an offer to repurchase outstanding debt at 101. CITGO would have a 60-day window in which to repurchase, providing some time to refinance debt or otherwise raise sufficient liquidity. 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 60-day repurchase window.

PDVSA Ownership Key Rating Constraint

While Fitch's criteria generally guides to a maximum of two notches between a weak parent and stronger subsidiary, it allows for discretion in other cases, including wider notching under circumstances where the parent may be heading for bankruptcy while the subsidiary operates with little risk of a consolidated bankruptcy filing. Fitch believes CITGO fits these criteria given structural features, including a lack of guarantees between the entities, restrictions on dividends to CITGO Holding and thereby PDVSA, asset location, U.S. jurisdiction, and the existence of Delaware C-Corps between PDVSA and the CITGO operating companies. However, Fitch believes the ratings linkage could potentially increase depending on the final terms of a PDVSA debt exchange.

There is a relatively strong operational linkage between CITGO and parent PDVSA. 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 structural and legal separations between the two entities. CITGO is a Delaware corporation with U.S. domiciled assets and is separated from ultimate parent PDVSA by two Delaware C-Corps, CITGO Holding, Inc., and PDV Holding Inc. The most important factor justifying the 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 restricted payments, asset sales, incurrence of additional indebtedness, and guarantees. CITGO debt has no guarantees or cross-default provisions related to PDVSA debt. However, as noted, the PDVSA exchange has the potential to increase linkage between the two entities.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for CITGO include:

--No major capital projects over the forecast horizon with annual capex of $300 million;

--Regional crack spreads decline to normalized levels over the forecast horizon;

--No material increases in corporate SG&A and refining operating expense per barrel;

--CITGO Petroleum pays approximately 100% of net income to CITGO Holding as available under the restricted payments basket.

RATING SENSITIVITIES

CITGO PETROLEUM

Negative: Future developments that may, individually or collectively, lead to negative rating action include:

--Execution of the PDVSA debt exchange on terms which increases CITGO's credit exposure to PDVSA via the pledge of 50.1% of CITGO Holding equity and potential change of control considerations, tightening the ratings linkage between the two entities;

--Weakening or elimination of key covenant protections contained in the CITGO Petroleum senior secured debt through refinancing or other means;

--Further weakening in credit quality at PDVSA;

--A sustained operational problem at one or more refineries.

Positive: Future developments that may, individually or collectively, lead to positive rating action include:

--Improved ratings at PDVSA given the explicit ratings linkage;

--Stronger structural separations between CITGO Petroleum and PDVSA leading to a wider notching rationale between the two;

--A change in ownership leading to a stand-alone credit analysis.

CITGO HOLDING

Negative: Future developments that may, individually or collectively, lead to negative rating action include:

--Execution of the PDVSA debt exchange on terms which increases CITGO's credit exposure to PDVSA via the pledge of 50.1% of CITGO Holding equity and potential change of control considerations, tightening the ratings linkage between the two entities;

--Weakening or elimination of key covenant protections contained in CITGO Holding senior secured debt through refinancing or other means;

--Further weakening in credit quality at PDVSA;

--Operational problems at CITGO Petroleum which negatively impacted the dividend stream to CITGO Holding.

Any change in existing covenant protections that weakened existing credit protections could change the rationale for notching between CITGO Petroleum and PDVSA, which could negatively impact the ratings at CITGO Holding.

Positive: Future developments that may, individually or collectively, lead to positive rating action include:

--Improved ratings at PDVSA or CITGO Petroleum given the explicit ratings linkages;

--Stronger structural separations between CITGO Holding and PDVSA leading to a wider notching rationale between the two;

--A change in ownership leading to a stand-alone credit analysis.

LIQUIDITY

At June 30, 2016, CITGO Petroleum had approximately $913 million in available liquidity, consisting of $817 million in revolver availability, $29 million in cash, and $67 million in availability on the A/R 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 in the event of another large move in crude oil or product prices. Fitch expects that capex, dividends, and other calls on liquidity will be funded primarily with operating cash flows. CITGO Petroleum has no maturities until the term loan B due in 2021, with a remaining principle of $639 million. CITGO Holdings secured term loan B is due in 2018, with a remaining principle of $656 million. As of June 30, the company has prepaid approximately $644 million of the term loan B through the excess cash flow feature of the credit agreement.

FULL LIST OF RATING ACTIONS

Fitch has placed the following on Rating Watch Negative:

CITGO Petroleum Corp.

--Long-Term Issuer Default Rating (IDR) 'B';

--Senior secured credit facility 'BB/RR1';

--Senior secured term loans 'BB/RR1';

--Senior secured notes 'BB/RR1';

--Fixed-rate industrial revenue bonds 'BB/RR1'.

CITGO Holding Inc.

--Long-Term IDR 'B-';

--Senior secured term loans 'B+/RR2';

--Senior secured notes 'B+/RR2'.

Date of Relevant Rating Committee: Sept. 21, 2016

Summary of Financial Statement Adjustments - Fitch has made no material adjustments that are not disclosed within the company's financial statements.

Additional information is available on www.fitchratings.com.

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)

https://www.fitchratings.com/site/re/869362

Parent and Subsidiary Rating Linkage (pub. 31 Aug 2016)

https://www.fitchratings.com/site/re/886557

Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers (pub. 05 Apr 2016)

https://www.fitchratings.com/site/re/879564

Additional Disclosures

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1012057

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Fitch Ratings
Primary Analyst
Brad Bell, CFA
Associate Director
+1-312-368-3149
or
Secondary Analyst
Mark Sadeghian, CFA
Senior Director
+1-312-368-2090
or
Committee Chairperson
Eric Rosenthal
Senior Director
+1-212-908-0286
or
Media Relations:
Alyssa Castelli, +1-212-908-0540
[email protected]


Source: Business Wire (September 22, 2016 - 11:59 AM EDT)

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