The Type of Debts O&G Companies Have Matters

Swiber shocked the stock market on Thu by announcing that it had applied to wind up the company. This is unexpected because based on latest financial results for 1Q2016, Swiber is still generating a positive operating cashflow. Anyway, the latest on this episode is that Swiber has applied to withdraw the winding-up application and apply for judicial management instead. The issue in this episode is the high indebtedness of the company. However, the nature of the debts also matters. Swiber has both bank loans and bonds. Had its debts been solely bank loans, the outcome might have been different.

To understand why, it is useful to look at DBS' announcement of the financial impact of Swiber's potential winding-up. DBS announced that its total exposure to Swiber, which comprises loans, bonds and off balance sheet items, is about SGD700M. The exposure is partially secured and it expects to recover half of the exposure. Of the estimated SGD350M of bad debt, DBS will tap on its general surplus allowances and book a loss of about SGD150M.

Given a choice, would DBS want the company to be wound up? If Swiber is kept afloat, the worst thing that could happen to DBS for now is Swiber does not repay its loans and interest on time. However, if Swiber is wound up, DBS would receive collaterals of SGD350M that are used to secure the loans and immediately realise a bad debt of SGD350M. What is the nature of the collaterals? If it is properties, it might be easy to sell them off quickly for a reasonable price at an auction. However, if it is Oil & Gas (O&G) vessels, then it might be hard to sell them off. Swiber's financial results for 1Q2016 listed the types of collaterals used to back the bank loans:

"The bank loans and finance leases are secured by:
(i) First legal mortgage over certain vessels and equipment.
(ii) Assignment of all marine insurances in respect of the vessels mentioned above.
(iii) Assignment of earnings/charter proceeds in respect of the vessels mentioned above.
(iv) Lessors’ title to the lease assets.
(v) Charge on certain trade receivables."

Among the items above, Item (v) trade receivables is most easily converted into cash, but it is not clear how much of the collaterals is in trade receivables. For Item (iii) charter earnings/ proceeds, Swiber reported charter hire income of USD74.6M but chartering expenses of USD168.9M in FY2015, so it is not clear how much cash this item can provide. It is likely that DBS will end up with some O&G vessels which cannot be liquidated quickly for a reasonable price. For the duration that the assets are on its books, DBS will have to spend some money to maintain those assets until sellers can be found.

On the SGD350M bad debt, even though DBS is able to tap SGD200M from its general surplus allowances and reduce the loss to SGD150M, that allowance must be replenished in subsequent quarters from increased provisions. The purpose of a general surplus allowance is to set aside some money every quarter to absorb potential losses so that the impact is more manageable. Earnings in subsequent quarters will be impacted. 

Thus, DBS has much to lose and little to gain from the unexpected winding-up of Swiber. Judicial management will be more beneficial for DBS, since Swiber is still able to generate a positive operating cashflow, as that will allow Swiber to continue operating, collect cashflow and hopefully, over time, it will be able to pay down the loans to DBS. The important corollary is this: banks will not pull the plug from O&G companies. When bank loans come due, banks will just let the O&G companies refinance, because if they do not, O&G companies will default on the loans and the issues discussed above will happen. In 1Q2016, Swiber repaid bank loans of USD137.6M but borrowed USD128.3M at the same time.

For further proof that banks will not pull the plug on O&G companies, you can refer to EMAS Offshore's 2Q2016 financial statement, which stated that it "had breached certain financial covenants relating to its borrowings. As at announcement date, the Group had rectified the breach by way of obtaining covenant waiver and/or amendments to the financial covenants by the lenders." Also, shipping trusts have been facing difficulties due to the shipping glut since the Global Financial Crisis. After 9 years, they are still around, because most of their debts are bank loans. Banks are financial institutions; they are mostly interested in getting back their money rather than owning illiquid assets. Having said the above, banks will also not blindly refinance O&G debts. If the company is not expected to generate positive cashflow and pay down the loans over time, banks will have no choice but to pull the plug at an appropriate time.

Bonds are different from bank loans. When bonds come due, there are usually only 2 choices: repay in full or default. There is no option to roll-over the bonds. Thus, prior to the bonds coming due, the company would have to find ways to raise cash in advance, so that there is money to repay the maturing bond. In the case of Swiber, it did not manage to complete the issue of USD200M of preference shares in end Jun, thus putting strains on its cash resources. As at end Mar 2016, Swiber had USD130.0M in cash. On 6 Jun and 6 Jul, it redeemed bonds totaling SGD205M (approximately USD153.0M). After repaying these 2 bonds, there is no much cash left. On 8 Jul, Swiber announced the receipt of the first letter of demand for USD4.8M, which triggered the chain of events that we have seen.

If its debts were solely bank loans, the outcome might have been different. Also, it is good to pay attention to companies with bonds that are maturing soon.

See related blog posts:

• Lessons for Investing in OSV Companies from Shipping Trusts
• The Missing Link Between Oil Price & O&G Profitability
• A Comparison of the 3 Local Banks