Submitted by�Tyler Durden�on 10/06/201

Commodity Trading Giants Unleash Liquidity Scramble, Issue Record Amounts Of Secured Debt

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 simplified 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 simplified 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 up in the coming weeks and months, because 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.

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Glencore Explains What Would Happen If It Is Downgraded To Junk

As part of its ongoing scramble to defend itself against "speculators" and concerns about its balance sheet, earlier today Glencore released a�4 page "funding worksheet" detailing all of its obligations.

Among the highlights was Glencore's disclosure of total available liquidity as of this moment, which the firm reported to be materially above its June level of $10.5 billion:

At 30 June 2015, available committed liquidity was $10.5 billion (p. 71 of 2015 Half-Year Report). As of today, committed available liquidity is materially above June’s level, given the recent $2.5 billion equity placement, the business generating positive free cashflow and the ongoing focus on delivery of the various other debt reduction measures, including lower net working capital. Further delivery of the debt reduction programme, including the $2 billion target for asset disposals, will similarly enhance liquidity levels.

It also presented its sources of funding among which the well-known $31.1 billion in bonds, as well as $20 billion in short-term funding split between a $15.25 revolver (of which a "substantial portion" is undrawn), $1.2 billion in AR/Inventory secured funding, and $3.4 billion in bilateral bank facilities. Glencore was quick to point out the gullibility of its bank lenders: "No financial covenants, no rating events of default or rating prepayment events, no material adverse change events of default or material adverse change prepayment events."

Next Glencore details the terms of its notes and cross-guarantees which it lays out as follows:

$36.5 billion notes outstanding at 30 June 2015, including $1.9 billion maturing in October 2015. See Appendix for full details.

• Notes are issued on a pari passu basis, applying a cross guarantee structure introduced at the time of the Xstrata acquisition (see Moody’s and S&P reports dated 7 May 2013 and 19 June 2013, respectively).
• Glencore Group bonds (issued by Glencore Funding LLC, Glencore Finance (Europe) AG and Glencore Australia Holdings Pty Ltd) have guarantees from Glencore plc, Glencore International AG and Glencore (Schweiz) AG (previously Xstrata (Schweiz) AG).
• Following the Xstrata acquisition, legacy Xstrata bonds (issued by Xstrata Finance (Canada) Limited, Xstrata Canada Financial Corp, Xstrata Canada Corporation and Xstrata Finance (Dubai) Limited) also now have guarantees from Glencore plc and Glencore International AG, implemented by way of supplemental indentures.
• Similarly, the outstanding USD notes issued by Viterra Inc. in August 2010 have guarantees in place from Glencore plc and Glencore International AG.

Glencore also notes the $17.9 billion in Letter of Credit commitments it had outstanding as of June 30:

As part of Glencore’s ordinary sourcing and procurement of physical commodities and other ordinary marketing obligations, the selling party (or Glencore voluntarily) may request that a financial institution act as either a) the paying party upon the delivery of product and qualifying documents through the issuance of a letter of credit or b) the guarantor by way of issuing a bank guarantee accepting responsibility for Glencore’s contractual obligations.

The LC is not incremental exposure to that already reported in the financial statements. An LC is only a “contingent” obligation, disclosed as such in Glencore’s financial statements i.e. becomes a liability in the event that Glencore does not perform on an already recorded liability. The underlying transaction / procurement liability is recognised within “Trade Payables” in Glencore’s balance sheet.�At 30 June 2015, $17.9 billion of such LC commitments have been issued on behalf of Glencore, with the respective liabilities reflected within the $28.1bn of recorded accounts payables. The contingent obligation settles simultaneously with the payment for such commodity. Availability is substantially higher, such that the vast majority of these Glencore facilities remain undrawn.

An interesting tangent is when Glencore discusses it readily marketable inventories:

Represents those marketing inventories that are contractually sold or hedged. At June 30 2015, total inventories were $23.6 billion, of which Marketing RMI were $17.7 billion.

For corporate leverage purposes Glencore accounts for RMI as being readily convertible to cash due to their very liquid nature, widely available markets and the fact that price exposure is covered by either a forward physical sale or hedge transaction.

Which brings up the very interesting question: with Glencore touting its revolver availability, and its various secured facilities, just how is Glencore marking the fair value of its inventories, because a ton of copper a year ago as collateral is worth just a little bit more than a ton of copper currently. We are confident Glencore's banks are aware of this.

But finally, and most importantly, Glencore presents what it believes would happen if it is downgraded from Investment Grade to Junk. This is what it says:

Glencore is undertaking measures to strengthen its balance sheet, including a material debt reduction, that the company expects shall serve to protect and maintain a strong BBB/Baa credit rating.

In the event of a downgrade by Standard & Poor’s and/or Moody’s from current ratings to the level(s) immediately below, a ratings’ grid in the $6.8 billion 5-year revolving credit facility provides for a modest additional margin step-up. As this 5-year revolving credit facility is expected to remain fully undrawn, the net additional effect would only be 35% of this modest step-up margin, being the applicable commitment fee only. The maximum margin for sub-investment grade rating from either Standard & Poor’s or Moody’s is 1.10%.�There is no ratings grid in relation to the $8.45 billion revolving credit facility. In addition, there are $4.5 billion of bonds outstanding, where a 125bps margin step-up would apply, in the event that the bonds were rated sub-investment grade by either major ratings agency.

Which reminds us of the waterfall analysis being shared around in the weeks before the AIG downgrade unleashed a series of events that ultimately led to the insurance company's bail out. It too presented glowing picture of the potential risks. In the end it was very deficient. One can only hope that Glencore has learned the lesson of never misrepresenting the worst case scenario.

Full letter below (link)

Glencore Funding

Glencore Funding

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GLENCORE TIMELINE

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