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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 took, presented glowing picture of the potential risks. In the end it was very deficient. One can only hope that Glencore's has learned the lesson of never misrepresenting the worst case scenario.

Full letter below (link)

Glencore Funding