DBRS Morningstar Downgrades Source Energy Services Canada LP and Source Energy Services Canada Holdings Ltd., Removes Under Review – Negative Status

DBRS Limited (DBRS Morningstar) downgraded Source Energy Services Canada LP and Source Energy Services Canada Holdings Ltd.’s (together, the Co-Issuers) Issuer Rating and Senior Secured First Lien Notes (the Senior Notes) rating to CCC (high) from B (low) and B, respectively. The action removes the Co-Issuers’ ratings from Under Review with Negative Implications, where they were placed on November 21, 2019. All trends are Negative. The recovery rating on the Senior Notes has been lowered to RR4 from RR3. DBRS Morningstar based its analysis on the consolidated financial statements of the ultimate holding company, Source Energy Services Limited (Source or the Company).

The removal of the Under Review with Negative Implications status of the ratings follows the Company’s announcement that it had (1) reached an agreement with its banking syndicate to lower the Fixed Charge Coverage Ratio applicable under the Company’s asset-backed credit facility (Credit Facility) from a minimum of 1.25 times (x) to 1.10x; and (2) received $5.9 million of insurance proceeds in connection with the accident at its Fox Creek terminal. The covenant relaxation and receipt of insurance proceeds should provide the Company with some near-term flexibility. However, oil field service (OFS) activity levels and pricing for OFS services in the Western Canadian Sedimentary Basin (WCSB) is expected to remain challenging in 2020 as oil and gas producers have large¬ly indicated that they will spend within cash flow until there is better visibility regarding market access for hydrocarbons out of the basin. The downgrade of the issuer rating reflects DBRS Morningstar’s expectation that the Company’s lease adjusted, debt-to-cash flow, and EBIT interest coverage ratios will remain well outside the range for the B (low) rating over the next 24 months because of weaker earnings and cash flow. The downgrade also acknowledges that Source’s liquidity continues to be a concern. While DBRS Morningstar’s expects Source to meet its obligations over the next 12 months from operating cash flow and available liquidity under the Credit Facility, the Company has minimum flexibility to withstand further reduction in activity levels. The downgrade of the Senior Notes by an additional notch reflects the change in recovery rating to RR4 (expected recovery of 30% to 60%) from RR3 (expected recovery of 60% to 80%) in the event of a default. The outlook for OFS activity levels in the WCSB is highly uncertain. Any improvement is conditional on better visibility for long-term market access out of the WCSB which is unlikely until at least 2021. Consequently, DBRS Morningstar expects valuation discounts to deepen in the event of a sale due to default in the near term.

The Negative trends primarily reflect the high degree of uncertainty associated with the refinance of the Senior Notes which mature in December 2021. The Company will have to pursue refinancing in an environment where access to capital markets for high-yield issuers in the Canadian OFS industry remains constrained. DBRS Morningstar notes that a distressed exchange of the Senior Notes could result in a Selective Default (See Default definition on dbrs.com).

DBRS Morningstar may further downgrade the ratings if financial performance is weaker than expected, liquidity worsens, or if the Company initiates a distress exchange on its Senior Notes. A rating upgrade is unlikely in the medium term and would require material improvement in the Company’s lease adjusted, debt-to-cash flow, and EBIT interest coverage ratios. DBRS Morningstar may change the trend to Stable if the Company successfully refinances the Senior Notes.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The principal methodologies are Rating Companies in the Oil and Gas and Oilfield Services Industries, DBRS Criteria: Guarantees and Other Forms of Support, DBRS Criteria: Recovery Ratings for Non-Investment Grade Corporate Issuers, and DBRS Morningstar Criteria: Rating Corporate Holding Companies and Parent/Subsidiary Rating Relationships, which can be found on dbrs.com under Methodologies & Criteria.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link under Related Documents or by contacting us at [email protected].

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

For more information on this credit or on this industry, visit www.dbrs.com or contact us at [email protected].

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