For an extended period now, the Marine, Oil & Gas industry is going through trying times for some time now. Going forward, it is going to be difficult to say what is next for them and many other industries
We know that bad times don’t last so are the bankers/relationship managers just out there to sell investment products for their own benefit? During good market cycles, when the company books are looking great, bonds are being issues to help provide the working capital for these companies. The moment the cash-flow stops, the banks stop lending or restructuring. Quite a tough and sad moment though.
Bond/Debt
I discussed about bonds/debts a few posts back and talked about public/private financing in the capital markets. What most companies did was to find some banks to finance their working capital with contracts and assumption of a stable cash flow and they would pay off interest to bondholders over a period of time. What the lead banks provided are in turn offered out to retail/institutional/HNWI to take on a portion of the bond. Most of the time, financing is offered in terms of Loanable Value.
An Example
Let’s use this example: I buy Bond S.Limited on point of purchase for the initial offering at Par Price (100.00). The bank who syndicate this capital raising and offer a portion to other parties so as to diversify the risk. When “Sophisticated” investors take on these investments I offer a 60% Loanable value.
It means that for every $1 worth of S.Limited bonds. The bank will be willing to finance you $0.60. All you need is $0.40 worth of cash. On each reinvestment amount, you get another 60% in loanable term.
a. When the real problem surface
When S.Limited announces that they may have issues repaying bondholders, then the same banks who finances the bond syndication would deemed these investments as not so valuable now and decides to tell you that you can’t lend anymore from the $0.60 previously as what they have valued the investment at so you have to make back the full amount in a few days’ time.
b. The real liquidity and Loanable value changes dynamically
I would think that this is as good as lenders telling the company that they will stop lending. To raise $0.60 from elsewhere isn’t really a problem for most people but how about $600,000 or $6,000,000 which I really doubt many of us have that kind of cash waiting around somewhere.
Sample Illustration
Mathematically, it can be easily understood. (Not really isn’t it looking at this complicated piece of calculation table) This is basically a long form of maximising the full loanable amount and then re-investing them back into the same investments and over again:
| Name of Security | Cash for Investment | Loanable Value | Loan Amount | Cash Used | Balanced Cash | Value of Portfolio (Nett of Loans) |
| S.Limited 6.00% 2025 | 1,000,000.00S$ | 60% | 600,000.00S$ | 400,000.00S$ | 600,000.00S$ | 1,000,000.00S$ |
| 600,000.00S$ | 60% | 360,000.00S$ | 240,000.00S$ | 360,000.00S$ | 1,000,000.00S$ | |
| 360,000.00S$ | 60% | 216,000.00S$ | 144,000.00S$ | 216,000.00S$ | 1,000,000.00S$ | |
| 216,000.00S$ | 60% | 129,600.00S$ | 86,400.00S$ | 129,600.00S$ | 1,000,000.00S$ | |
| 129,600.00S$ | 60% | 77,760.00S$ | 51,840.00S$ | 77,760.00S$ | 1,000,000.00S$ | |
| 77,760.00S$ | 60% | 46,656.00S$ | 31,104.00S$ | 46,656.00S$ | 1,000,000.00S$ | |
| 46,656.00S$ | 60% | 27,993.60S$ | 18,662.40S$ | 27,993.60S$ | 1,000,000.00S$ | |
| 27,993.60S$ | 60% | 16,796.16S$ | 11,197.44S$ | 16,796.16S$ | 1,000,000.00S$ | |
| 16,796.16S$ | 60% | 10,077.70S$ | 6,718.46S$ | 10,077.70S$ | 1,000,000.00S$ | |
| 10,077.70S$ | 60% | 6,046.62S$ | 4,031.08S$ | 6,046.62S$ | 1,000,000.00S$ | |
| 6,046.62S$ | 60% | 3,627.97S$ | 2,418.65S$ | 3,627.97S$ | 1,000,000.00S$ | |
| 3,627.97S$ | 60% | 2,176.78S$ | 1,451.19S$ | 2,176.78S$ | 1,000,000.00S$ | |
| 2,176.78S$ | 60% | 1,306.07S$ | 870.71S$ | 1,306.07S$ | 1,000,000.00S$ | |
| 1,306.07S$ | 60% | 783.64S$ | 522.43S$ | 783.64S$ | 1,000,000.00S$ | |
| 783.64S$ | 60% | 470.18S$ | 313.46S$ | 470.18S$ | 1,000,000.00S$ | |
| 470.18S$ | 60% | 282.11S$ | 188.07S$ | 282.11S$ | 1,000,000.00S$ | |
| 282.11S$ | 60% | 169.27S$ | 112.84S$ | 169.27S$ | 1,000,000.00S$ | |
| 169.27S$ | 60% | 101.56S$ | 67.71S$ | 101.56S$ | 1,000,000.00S$ | |
| 101.56S$ | 60% | 60.94S$ | 40.62S$ | 60.94S$ | 1,000,000.00S$ | |
| 60.94S$ | 60% | 36.56S$ | 24.37S$ | 36.56S$ | 1,000,000.00S$ | |
| 36.56S$ | 60% | 21.94S$ | 14.62S$ | 21.94S$ | 1,000,000.00S$ | |
| 21.94S$ | 60% | 13.16S$ | 8.77S$ | 13.16S$ | 1,000,000.00S$ | |
| 13.16S$ | 60% | 7.90S$ | 5.26S$ | 7.90S$ | 1,000,000.00S$ | |
| 7.90S$ | 60% | 4.74S$ | 3.16S$ | 4.74S$ | 1,000,000.00S$ | |
| 4.74S$ | 60% | 2.84S$ | 1.90S$ | 2.84S$ | 1,000,000.00S$ | |
| 2.84S$ | 60% | 1.71S$ | 1.14S$ | 1.71S$ | 1,000,000.00S$ | |
| 1.71S$ | 60% | 1.02S$ | 0.68S$ | 1.02S$ | 1,000,000.00S$ | |
| 1.02S$ | 60% | 0.61S$ | 0.41S$ | 0.61S$ | 1,000,000.00S$ | |
| 0.61S$ | 60% | 0.37S$ | 0.25S$ | 0.37S$ | 1,000,000.00S$ | |
| 0.37S$ | 60% | 0.22S$ | 0.15S$ | 0.22S$ | 1,000,000.00S$ | |
| 0.22S$ | 60% | 0.13S$ | 0.09S$ | 0.13S$ | 1,000,000.00S$ | |
| 0.13S$ | 60% | 0.08S$ | 0.05S$ | 0.08S$ | 1,000,000.00S$ | |
| 0.08S$ | 60% | 0.05S$ | 0.03S$ | 0.05S$ | 1,000,000.00S$ | |
| 0.05S$ | 60% | 0.03S$ | 0.02S$ | 0.03S$ | 1,000,000.00S$ | |
| 0.03S$ | 60% | 0.02S$ | 0.01S$ | 0.02S$ | 1,000,000.00S$ | |
| 0.02S$ | 60% | 0.01xS$ | 0.01S$ | 0.01xS$ | 1,000,000.00S$ | |
| 2,499,999.97S$ |
Total Amount / (1-Loanable value) = $1,000,000 / (1-60%) = $2,500,000
With $1, the bank can loan you up to $2.50 presumably that you reinvest them into the same bond. Total investments become $3.50 (e.g. Nett of loans, $3.5 – $2.5 = $1). The Nett portfolio value still remains the same but that comes with plenty of risks:
1. You leave no buffer for any mark to market movement
2. You become concentrated into one single asset class and one company
3. Loans means you have to service the interests on a regular basis so with increase in interest rates, that brings your return lesser though you have taken more risks
4. In times of liquidity and crisis, most likely you will not be able to sell your holdings as fast
5. When you hit a margin call, you most likely have to top-up your cash balances as soon as possible or that would become a sell-out eventually at the current price.
On the flip side,
1. You maximize fully what leverage can bring you.
2. Yield is increased because of the leverage factor.
3. Returns will eventually increase with a higher risk taken.
What is your investment profile?
Again, it brings us back to basics again. That high risk taker with a long horizon? The conservative investor that is skeptical? I am not surprised that there are high risk takers who doesn’t mind this scheme. Then again, if you know the risks you are taking then take it like a man.
I’ve met and known people who are so egoist about their aggressive investments ideas. When shit his the fence, they do point the finger on others. Unfortunately, they know the risks that comes with. When it comes to money, humans behave differently.
Increasing Debt
There are businesses who keeps increasing their loan size at every maturity. When you look at the cash flow, they are paying out more than 100% from what they make. It is similar to spending more money than what you make. In this aspect, it seems like the company wanted to:
1. Keep investors happy that they are receiving the dividends
2. Ensure that their stock price on the exchange stays stable
3. Waiting out for the bad cycle to ride through and business to pick up again.
Extending Debt result
1. The money paid out have to be taken from somewhere and most of the time it is from a bond and restructured many times most likely
2. Anyone who digs deeper into the company details will know the state of their company
3. The cycle may not ever recover for the company to be relevant anymore
It is important to be thrifty and know how much you can afford to spend. Does looking rich or being rich matter more to you?
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