More on the margin but not marginalised

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Access to fast cheap short-term debt is more important in commodities trading than most sectors. But not all traders get similar margins or speed of delivery. So what generates the tightest margins and is there a growing mismatch between timing in the lending/borrowing dynamic of both markets? 

Three global commodities trading houses – Noble, Glencore and Gunvor. Three one-year annual short-term borrowing refinancings in the same month. Three sets of margins that are not even within 50bp of each other.

That 50bp-plus margin difference has more significance in the commodity trading market than other sectors. Cheap credit is the lifeblood of commodities trading where margins are size zero and profits rely on shipping large volumes. Consequently, the cheaper the debt the more significant the competitive trading advantage of the borrower.

In May, all three trading houses closed one-year revolvers, either as standalones or as a part of larger deals.

The margin on Noble’s $1 billion one-year tranche (part of a $3 billion deal that included a $2 billion one-year revolving borrowing base facility) was 225bp over dollar Libor - more than double the 85bp margin Noble paid for a similar $1.15 billion facility in May 2015.

Gunvor Singapore (with a parent guarantee) also closed a $955 million one-year revolver (part of a $1.041 billion deal that included an $86 million three-year tranche) with a margin of 140bp over Libor – a 15bp decrease in margin on the previous year’s facility.

And Glencore raised $7.7 billion of one-year debt priced at an all-in of 95bp over three-month Libor with a 50bp margin - 10bp higher than the previous year.

The pricing comparison verges on artificial: Gunvor is a private company while Noble and Glencore are listed. Gunvor is not rated while the latter pair are. And performance of all three in a down market has also been radically different. Gunvor posted record net income of £1.25 billion in 2015, Noble a net loss (its first in 20 years) of $1.67 billion after taking $1.2 billion in write-downs related to the value of long-term contracts it has been accused of overstating; and Glencore net income of $1.34 billion, down 69% on the previous year.

But there is also a lot of commonality between the three traders. They make much of their revenues from oil, mining and metals (albeit Gunvor and Noble are scaling back on mining and metals). And all three, theoretically, as buyers and sellers of commodities, should have the ability to fix their own margins.

Given the performance of the traders it is unsurprising that Gunvor’s record result spawned a 10bp decrease in pricing year-on-year and Noble’s record loss more than doubled its cost of debt. However, the 10bp increase in margin on Glencore’s facility – still giving it the lowest cost of debt among all three borrowers – is harder to fathom given a 69% drop in net income.

But as one London-based banker notes of Glencore: "What you don’t see is the vast amount of trade financing fees that Glencore generates for its lenders. That additional business is lucrative and very short dated. So Glencore is a good fee earning account that has relatively low capital against it for most banks".

None of this bodes well for Noble which, like Glencore, is about to generate a lot of ancillary fees for lenders - but not the kind that boost bank appetite and bring margins down.

Noble continues to lurch from liquidity crunch to liquidity crisis. Having hoarded cash at the expense of trading volume, to maintain its credit rating prior to its fundraising, Noble has just had its rating downgraded again by Standard & Poor’s (S&P) from BB- to B+ with a negative outlook post-fundraising.

The downgrade puts Noble a notch below non-investment grade and is particularly onerous given the margin on Noble’s $3 billion combined RCF and borrowing base facility is linked to its maintaining a Ba3/BB-/BBB- rating.

According to S&P Noble’s liquidity is still “less than adequate,” in part because the company will need to refinance a large chunk of its loans over the next year and “continued commitment from banks will depend on the successful execution of the company’s business rationalization [the sale of Noble America Energy Solutions which is being arranged by Morgan Stanley and HSBC].”

The main reasons for many of Noble’s woes are well documented: A vast increase in leverage and costs spawned by acquisitions that subsequently backfired; upfront accounting for a portion of gains from long-term marketing and supply agreements in a volatile commodities market where the amount of cash eventually received from deals can be lower than the recorded profits (net fair value gains on contracts and financial derivatives became equivalent to more than 80% of Noble’s equity value); and an unwillingness to downsize the business and reduce leverage.

But there are other issues plaguing Noble that go to the heart of the commodities trading business. For example, since listing both Noble and Glencore have had to smooth revenues to keep shareholders comfortable – not easy in the volatile world of commodities and the reason behind Noble’s adoption of its upfront accounting practises. In short – public shareholders and commodities trading are not an easy match which for many traders means fundraising via an IPO is out of the question.

Furthermore, since the global downturn in commodities pricing and tightening Basel regulation on lenders, bank due diligence is taking much longer and facilities that once took commodities traders 30 days to arrange are now taking three months.

Consequently there is a growing timing mismatch between fast paced, high volume commodities trading and access to short-term liquidity. Borrowers now have to take on much larger volume and longer tenor short-term debt to ensure they have the liquidity in place to meet all circumstances, whether it is drawn or not, simply because the arranging period has become so much longer.

Despite the problems, the bank market continues to keep faith with major commodities traders. No commodities trading borrower has failed to raise fundraising this year and margins have been relatively competitive given the backdrop in both the bank and commodities market. Margins are not going to tighten for some time, but liquidity appears to be available – even for Noble.

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