Earlier today, in its latest attempt to restore confidence in its brand and business model after suffering a historic stock price collapse, Glencore – whose CDS recently blew out to a level implying a 50% probability of default – released a 4 page funding worksheet which was meant to serve as a simplied summary of its balance sheet funding obligations and lending arrangements to equity research analysts who have never opened a bond indenture, and which among other things provided a simplied and watered-down estimate of what could happen if and when the company is downgraded to junk.
Meanwhile, in a furious race to shore up as much liquidity as possible, Glencore – which a month ago announced a dramatic deleveraging plan – and its peers have been quietly scrambling to raise billions in secured funding. Case in point none other than Glencore’s biggest competitor and the largest independent oil trader in the world, Swiss-based, Dutch-owned Vitol Group, whose Swiss unit Vitol SA earlier today raised a record $8 billion in loans.
It is not alone.
As Bloomberg reports, another name profiled previously here, privately-held (but with publicly-traded debt) Trafigura “won improved terms on a $2.2 billion loan refinancing deal on Oct. 1 via a group of 28 banks. Swiss commodity traders Gunvor Group Ltd. and Mercuria Energy Group Ltd. are also marketing credit facilities totaling $2 billion.”
Louis Dreyfus Commodities, the world’s largest raw-cotton and rice trader, said in its interim report last month that it had six revolving credit facilities with staggered maturity dates totaling $3.3 billion. In June, it amended and extended its North American facilities totaling $1.6 billion and in July it refinanced a $400 million Asian lending facility with the company securing an option to request an increase of $100 million.
Noble Agri, the agricultural commodity trader majority owned by China’s Cofco Corp., attracted four new lenders to its $1.58 billion one-year revolving credit facility, people familiar with the matter said this month.
In short – a race against time to pledge as much unencumbered collateral as possible for future funding needs, because as every CEO knows you raise capital when you can, not when you have to. Yet this is odd, because even as the companies hold investor meetings and publicly comfort investors that they are adequatly funded and see no need for a liquidity-raising scramble, that’s precisely what the world’s commodity traders are doing.
Bloomberg’s take was more optimistic: “The transactions show banks are still eager to loan money to commodity traders even after debt concerns caused by wild swings in Glencore’s stock and bond prices.”
The new loans and refinancing signal banks are comfortable lending to commodity traders, whose business models allow them to profit from volatility and lower financing costs amid weaker prices for raw materials.
According to Bloomberg, Vitol’s record credit facilities from a group of 57 banks were increased by a third after the initial $6 billion sought by the trading house was oversubscribed by $2.7 billion, the Rotterdam-based company said in a statement. The facilities, refinancing a debt package signed 12 months ago, are the biggest in the firm’s 49-year history, a Vitol spokeswoman in London said.
Then comes even more spin:
The loan package, coming after Trafigura last week agreed to lower lending rates, suggests some analysts don’t understand the business of trading houses, which can benefit from lower commodity prices and the current contango market structure that allows them to profit by storing oil because forward prices are higher than current costs.
Actually analysts (at least credit) understand the business of trading houses very well; what Bloomberg’s reporters don’t seems to understand, however, is the principle of muturally assured megaleverage destruction, or the implied threat for a company’s secured lending syndicate that a borrower which already has billions of exposure to banks has all the leverage in demanding even more debt. After all, should Vitol fail, it would lead to a cascade of bank failures as all the banks that have lent money to the giant commodity trader are forced to charge off their exposure, in the process leading to serial defaults among undercapitalized financial institutions.
It is these institutions whose credit officers underwrote the loans, that are the ones who “don’t understand the business of trading houses” because based on the recent collapse in publicly traded securities, they never modelled what happens to cash flows in a world in which the price of oil, copper, zinc, aluminum or other commodities, suffer a 50%+ plunge in prices.
“Given the recent turbulence in the commodities space, we have been repeatedly asked by investors on the banks’ exposure to commodity traders,” analysts at Sanford C. Bernstein led by Chirantan Barua wrote in a note Monday.
As they well should, and in order to avoid answering, the banks are perfectly happy to throw a little more good money after lots of bad money in order to avoid remarking their entire exposure to the sector to something resembling fair value.
But the day of remarking is coming: as Bernstein calculates, commodity traders have raised at least $125 billion of debt, of which about $75 billion is loans. In other words, there is about $75 billion in secured debt, collateralized by either inventory and/or receivables collateral whose value has cratered in the past year, and as a result the LTV on the secured loans has soared. It is this that is prompting the panicked banks to be more eager to provide funds to the suddenly distressed energy-trading sector than even the borrowers themselves. And after all, if the banks do blow up, there is always the taxpayer-funded bailout as a last reserve.
And here is a pop quiz to either analyst, or Bloomberg writers who don’t “understand the the business of trading houses” – if you issue secured debt to shore up liquidity as a result of what is fundamentally a massively overlevered capital structure, does the pro forma debt increase or decrease. This is not a trick question.
The good news for the Vitols of the world is that by pledging even more of their unencumbered assets to banks, they buy themselves a few more months, or quarters, of liquidity to pay down upcoming maturities and interest. Which is what Glencore did with its “doomsday” plan in early September… a plan which calmed the stock for all of two weeks before investors saw right through it for what it was: a desperate scramble to put lipstick on a declining-stage supercycle pig.
In the meantime, the end result is this: companies that are even more levered to commodity prices in a world in which at last check commodity prices, a proxy for China’s economy, are sliding. Which, incidentally, was our thesis in March of 2014 when we said that buying Glencore CDS is the best way to trade China’s hard landing. This is precisely what happened.
Which is why both the companies, and their lending banks, better pray that commodity prices pick upin the coming weeks and months, becuase for the Vitols, the Glencores, the Trafiguras, the Mercurias and so on, that is all that matters. Ironically, by levering up even more, they bought themselves some time now, but if and when the next leg down in the commodity supercycle takes place, the pain will only be that much greater.