DIVERSIFIED ENERGY COMPANY PLC
Fitch Ratings has affirmed
The Rating Outlook is Stable.
The affirmation is based on Fitch's view of the performance and additional hedges added to the transaction since closing.
RATING ACTIONS
Entity / Debt
Rating
Prior
Diversified ABS Phase III
Class A 255125AB2
LT
BBB
Affirmed
BBB
Page
of 1
VIEW ADDITIONAL RATING DETAILS
Transaction Summary
The notes are collateralized by a portion of the operated and non-operated working interests from
The current valuation is based on strip pricing for oil and gas, as of
The transaction has seen improved hydrocarbon production compared to closing Fitch base case expectations through the 18 months of reporting. Overall expenses have been inflated versus original expectations, largely due to the pricing environment. However, added hedges are expected to benefit
KEY RATING DRIVERS
PDP Production In Line with GC1 (Positive): Fitch considers the PDP production risk of the assets being transferred by the sponsor to be in line with a Going Concern (GC) Assessment score of GC1, allowing rating levels up to the 'A' rating category. PDP production is not dependent on any future development capex, which gives it a competitive advantage over other oil and gas reserves and, therefore, is less sensitive to commodity price declines.
The transaction portfolio consists of greater than 50,000 PDP wells that have a weighted average life/seasoning of over 11 years and is heavily weighted toward natural gas making up more than 70% of the revenue. The decline profile has been historically stable and Fitch expects it to remain stable over the life of the transaction
Limited Future Generation Risk (Positive): The future generation of the flows is expected to continue with limited disruption in the event of an operator bankruptcy. Therefore, Fitch has not directly linked the transaction rating to the credit quality of
Base Case and Stressed Case Production Levels (Neutral): Fitch's base case production levels have been derived from third-party independent engineer (IE) reports to determine reserve estimates and production levels based on the existing PDP reserves. Fitch's base case was generally in line with the IE projections due to the historical stability of production, the diversified portfolio and the average life of the wells. Fitch ran various stresses on the IE production levels to simulate potential future volatility in production and overall volumetric risk.
Majority of Price Risk Hedged (Positive): The transaction currently mitigates the majority of price risk through hedges covering 85% of gas production, but not more than 95% for the first five years, through
Fitch stresses the unhedged portion of the portfolio as outlined in its 'Future Flow Securitization Criteria.' The hedges on the production volumes help to mitigate the commodity price risk, but the residual exposure beyond the 85% and the rolling nature of the hedges limit the transaction to the 'BBB' category.
Net Cash Flows Subject to Operating Expenses (Negative): The continuous generation of the securitized revenue stream is dependent on the net cash flows related to each well. These net cash flows relate to production levels and price at the wellhead minus all expenses. While each well may experience some volatility related to operating costs on an individual basis, the overall operating costs of the portfolio are fairly stable. However, certain expenses are subject to increases in inflation and other factors; therefore, Fitch stressed the fixed and variable costs to absorb potential future volatility.
Leverage and Coverage Levels (Positive): Using the IE estimates, the notes are expected to have average debt service coverage ratios (DSCRs) of approximately 1.50x for class A notes, considering hedged prices along with strip prices for any unhedged portion. Fitch's base case scenario, which includes adjustments to the IE production and expenses, is expected to be approximately 1.45x for the life of the transaction. Actual DSCR since closing has averaged 2.54x.
Loan-to-value (LTV) is a supplemental metric when analyzing leverage, and Fitch's base case full-life LTV for class A notes is 57.3% (60.6% 17-year PV-10).
In addition, Fitch utilizes the loan life coverage ratio (LLCR) to determine if there is sufficient coverage in the different scenarios. The IE estimates LLCR for class A at 2.22x. In Fitch's base case, the LLCR was 2.14x.
Fitch believes the coverages and LTV ratios are in line with the ratings assigned for class A notes due to the amortization profile and stability of expected production and expenses.
Financial Structure (Positive): The transaction benefits from significant structural protections including backward looking cash sweep mechanisms based on DSCR and production tracking levels. The LTV trigger provides some forward-looking view as it relates to the overall leverage relative to the current expected value. The cash-sweep triggers will allow the notes to de-lever on an accelerated basis if the performance of the transaction is not in line with the IE base case expectations. The transaction also benefits from a six-month liquidity reserve account to cover monthly interest payments and senior expenses
Asset Isolation and Legal Analysis (Neutral): The issuer has acquired the assets through an asset purchase and contribution agreement. Fitch has reviewed legal opinions that the SPV's assets have been properly conveyed and that the issuer's assets will not be consolidated and remain separate in the occurrence of a bankruptcy of the sponsor or operator.
Counterparty Risks (Neutral): Fitch analyzed the transaction's exposure to counterparty risk in line with its 'Structured Finance and Covered Bonds Counterparty Rating Criteria.' Eligibility thresholds are outlined as investment grade, which is in line with Fitch's criteria for the 'A' category level. As part of this analysis, Fitch analyzed the potential for payment disruption and co-mingling risk, and the six-month reserve account is sufficient to mitigate this risk. The swap counterparty and the associated ISDA agreement have been reviewed and Fitch will evaluate whether a downgrade of the swap counterparty below the transaction rating will affect the rating on the notes.
RATING SENSITIVITIES
Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade
The credit strength of the transaction is linked to the production levels of the portfolio of assets, as well as fluctuations in overall expenses, which may ultimately reduce the net securitized cash flow. Significant decreases in production relative to the projected production will have a negative impact on the rating.
Although the transaction will hedge the majority of price risk related to natural gas, NGLs and natural gas basis for portions of time during the life of the transaction, a significant change in basis or a long-term reduction in commodity prices may have a negative impact if the transaction goes beyond the expected maturity of the notes. Moreover, the transaction may not be de-linked from the hedge counterparties, so a downgrade of a hedge counterparty below the respective threshold of the note's ratings will affect the transaction rating.
Any changes in these variables will be analyzed in a rating committee to assess the possible impact on the transaction rating.
Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade
As described above, the transaction is capped in line with the criteria. Furthermore, the class A notes are currently constrained to the 'BBB' category due to exposure to a single-operator. A positive rating action/upgrade could be considered if there is a significant reduction in expenses, increases in the levels of production or the addition of hedges that lead to an increase in securitized net cash flow.
USE OF THIRD PARTY DUE DILIGENCE PURSUANT TO SEC RULE 17G -10
Form ABS Due Diligence-15E was not provided to, or reviewed by, Fitch in relation to this rating action.
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
The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' 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. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.
Additional information is available on www.fitchratings.com
(C) 2023 Electronic News Publishing, source
