Chesapeake Energy Asset Sales Could Breach Bank Debt Rules

For Chesapeake, the asset sales and likelihood of impaired assets could create a scenario where its proven reserves level falls so much that it immediately triggers the banks calling the company on its debt. For a company that is leveraged much more than most peers and that has tried to calm investors by saying, among other things, that most of its debt doesn't even begin to reach maturity until 2015 at the earliest, this admission from Chesapeake in the 10-Q is the exact type of liquidity conundrum that has always been feared by critics of the company.

Phil Weiss, Argus Research analyst and a long-time critic of Chesapeake, stressed that it would be premature to be specific on what could occur based on the Chesapeake statement in the 10-Q because it was vague. In general, though, lower proved reserves and lower cash flow as a result of the sale of producing assets could potentially impact the company's ability to comply with its debt covenants.

Tim Rezvan, analyst at Sterne Agee, added simply, "This is why the stock is tanking." However, Rezvan added that his initial reading of the language in the filing indicated it was only Chesapeake's planned volumetric production payment (or VPP), a financing agreement to sell the right to future oil and gas revenue streams, that seemed to be off the table.

Chesapeake categorically denied this reading, with a Chesapeake spokesman saying that there are no changes to its current asset monetization plans.

The company has planned a sale of its Permian basin assets, a joint venture in the Mississippian Lime, and an Eagle Ford VPP. In fact, Chesapeake's largest shareholder, Southeastern Asset Management, who has recently become more vocal about the company's issues, cited the looming VPP as one reason to not panic about the company's ability to make ends meet and return value to shareholders.

Rezvan said that any restrictions on cash raising are an issue for the company, but if it were limited to the VPP, it would not be a huge issue.

Weiss said it seemed curious that the language in the 10-Q, which specifically refers to the Permian and Mississippian Lime asset deals, does not now include the Eagle Ford VPP, but the analyst said that regardless, it's the broader statement about any asset sales being delayed due to bank debt terms that is more important.