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Visualizing Aubrey McClendon "Rehypothecation" Scheme... And The China Trail

Tyler Durden's picture




 

Aubrey McClendon is no amateur when it comes to shady personal transactions involving his company, nat gas giant Chesapeake: Back in October 2008, just after the financial crisis erupted, he was forced to sell more than 31 million Chesapeake shares for $569 million to cover margin calls generated from buying CHK stock just prior on margin. The company’s stock fell nearly 40 percent the week of McClendon’s share sales. McClendon issued an apology but the company’s credibility with many shareholders suffered significantly. It looks lie the story is repeating itself, only this time the margined security is not company stock, but company loans. As Reuters reports in a must read special report "Since he co-founded Chesapeake in 1989, McClendon has frequently borrowed money on a smaller scale by pledging his share of company wells as collateral. Records filed in Oklahoma in 1992 show a $2.9 million loan taken out by Chesapeake Investments, a company that McClendon runs. And in a statement, Chesapeake said McClendon’s securing of  such loans has been “commonplace” during the past 20 years. But in the last three years, the terms and size of the loans have changed  substantially. During that period, he has borrowed as much as $1.1 billion – an amount that coincidentally matches Forbes magazine’s estimate of McClendon’s net worth." Ah yes, net worth calculations, which always focus on the assets, but endlessly ignore the liabilities (as Donald Trump will be first to admit). But ignore that: what is more notable here is the circuitous way that McClendon basically lifted himself by his, or rather CHK's bootstraps: all the loans are collateralized by his 2.5% working interest in new CHK wells drilled every year. In essence a roundabout way of generating "cash" by hypothecation, and levering into an "upside" corporate case. Should CHK however incur asset impairments, and/or if the current price of gas stays at or $2.00, then not only will CHK be gutted but so will the asset quality securing the private loans to the CEO, which on top of everything have no covenants ("There are no covenants or obligations in my loan documents or mortgages that bind Chesapeake in any way," McClendon wrote in an email to Reuters.) and thus no stakeholder protections. Is it any wonder then that CHK is getting creamed as of right now as investors are once again reminded that CHK may not quite play by the rules?

All this can be visualized as follows:

What specifically are the loans:

  • In June 2009, McClendon agreed to borrow up to $225 million from Union Bank, a California lender, pledging his share of wells as collateral.
  • In December 2010, he borrowed $375 million from TCW Asset Management, a private equity firm.
  • And in January 2012, McClendon borrowed $500 million from a unit of EIG Global Energy Partners, a private equity firm formed by former TCW  executives. It is unclear how much, if any, of those loans have been repaid.

Someone over at TCW really likes Aubrey. Someone with Chinese backing. Reuters digs in:

The lender behind $500 million worth of Aubrey McClendon’s personal loans is a private equity firm with headquarters across the street from the White House and the Chinese government as a minority owner. The firm, EIG Global Energy Partners, is run by R. Blair Thomas, an attorney and veteran energy investor. Formerly the Energy & Infrastructure Group of Trust Company of the West, EIG spun out of TCW in January 2011. It had $9.5 billion under management at the end of last year.

 

Those deep pockets – along with special ties to McClendon - have enabled it to bankroll his share of Chesapeake wells, according to minutes of a February 2011 meeting between EIG and the New Mexico State Investment Council, the state’s public investment fund.

 

At the meeting, EIG chief operating officer Randall Wade sought a $50 million investment from New Mexico. Asked about a prior EIG investment in McClendon’s well interests, Wade boasted EIG had known Chesapeake for more than 25 years and “provided pre-IPO financing for them in the late 1980s.”

 

Those tight bonds, Wade said, have created other unique opportunities for EIG. “In fall 2008, Mr. McClendon didn’t have liquidity to participate in the (well) program in 2009, at which point EIG entered into discussions with him and ultimately” formed a special purpose vehicle called Larchmont Resources, Wade said. Through Larchmont, EIG acquired the rights to all of McClendon’s well stakes for 2009 and 2010. EIG then set up a new  special purpose vehicle – Jamestown Resources – to control McClendon’s well shares in 2011, with rights to 2012, Wade said.

 

EIG’s investments have been extremely profitable. “EIG sweeps 100 percent of the cash flow generated by those projects until EIG has gotten all of  its money back plus a 13 percent realized return,” Wade told New Mexico investors. EIG also gets a 42 percent cut of McClendon’s share of the well  profits “in perpetuity,” he said.

 

EIG declined comment.

 

In February, EIG announced that China Investment Corp.(CIC), China’s sovereign wealth fund, had acquired a minority stake for an undisclosed amount. CIC declined comment.

Hmm, the last time we saw special purpose vehicles was around the time of Enron and Lehman. They rarely end well. And something tells us that CIC knows this too well. What we would like to know is what happens when the inevitable capital shortfall occurs, because China has deep pockets, and can afford to wait until natgas hits $0.00, or goes negative (yes, it is technically possible), and CIC is forced to "take out" the stake of other EIG partners. Because last we checked, China was doing all it can to rapidly mobilize recently nationalized YPF's assets. Has Aubrey merely become the patsy to allow China a foothold in US nat gas interests?

Finally, to all those scrambling to short the company: beware. CHK has a history of being able to fund itself with HY bonds and other unsecured debt come hell or high water. If and when the stock tanks, the short interest will surge on expectations of a funding shortfall. Alas, courtesy of the Fed's malevolent capital misallocation enabling, we are more than confident that the firm will be able to issue as much HY debt (unsustainably at 10%+, but that is irrelevant for the short-term) as it needs, crushing all short theses. What this means, simply, is that anyone who believes traditional fundamental analysis will and should work in the CHK case is likely to get burned, especially if China is involved which will have its own tactics vis-a-vis the future of McClendon and/or CHK. And all, of course, courtesy of the Chairman of course.

Full Reuters special report here.

 

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Wed, 04/18/2012 - 10:26 | 2354703 hedgeless_horseman
hedgeless_horseman's picture

 

 

What we would like to know is what happens when the inevitable capital shortfall occurs and CIC is forced to "take out" the stake of other EIG partners.

Same as it ever was.  Remember Interworld Corp?  What was the quote from the WSJ article?  Something like, "At no time have so many people had so much net worth for so short a time." 

 

Wed, 04/18/2012 - 10:27 | 2354712 French Frog
French Frog's picture

Would you expect anything else from a guy called Audrey?

Edit: now is it Audrey or Aubrey as both are used in the article?

Wed, 04/18/2012 - 10:36 | 2354720 hedgeless_horseman
hedgeless_horseman's picture

 

 

Except now, the investment banks have smartened up a bit.  They advise the companies to make the loans directly.  Brilliant!

Can't have upper management selling stock, you know. 

Insider selling looks so bad. 

We'll just loan them the money!

Yeah!

Really we can't have anyone selling stock.

Agreed.  I heard it is un-American. 

Wed, 04/18/2012 - 11:01 | 2354836 Vince Clortho
Vince Clortho's picture

Are those the speculators that Obama keeps pointing his finger at?

Wed, 04/18/2012 - 18:13 | 2356354 sgt_doom
sgt_doom's picture

                         Obama and the Naked Swap

I agree with everything President Obama says about oil speculation --- but I disagree and despise his actions in support of massive speculation.

President Obama reappointed the author of much of the Gramm-Leach-Bliley Act, Neal Wolin, and two major supporters of the Commodity Futures Modernization Act, Gary Gensler to the CFTC and Larry Summers, who is no longer with his administration.

President Obama’s Treasury Secretary Geithner, and his treasury department, strongly supported keeping naked swaps --- the most valuable tool in large-scale commodities speculation.

To date, all actions of the Obama administration have allowed and encouraged the very speculation he denounces!

Much of the entire speculation spectrum:  (1) unlimited number of credit default swaps allowed against bonds, etc. (naked swaps); (2) unlimited number of commodity futures contracts allowed against specific commodities or categories; (3) unlimited number of investors allowed per hedge fund; and (4) naked short selling via DTCC’s Stock Borrow Program, were realized during the Clinton administration, and expanded under the Bush and Obama administrations!

I am a lifelong democrat --- I would love to support Obama, but Obama, Biden, and both Clintons are simply just some more neocons.

Wed, 04/18/2012 - 11:32 | 2354953 Beatscape
Beatscape's picture

I'm a heavy investor in the energy sector, and I've never trusted Aubrey and would never and have never owned CHK--I don't care what the acerage is worth.  It is a bit odd that this seems to be culminating today with the Reuters article since most of this is already known and his wild cowboy style is well known, but sometimes all it takes is a little push to knock down the dominoes and the run for the exit becomes contagious.  Aubrey clearly does not have shareholders' best interest in mind when he does these types of push-the-limit questionable loan transactions.  He leverages the company to the hilt to favor his pocketbook and now it is backfiring.

By comparison, I have much of my portfolio invested in an opposite type of CEO--Richard Kinder of KMP, who only pays himself $1 per year and completely places himself in the shoes of shareholders by tying 100% of his compensation to KMP's distributions.

 

Wed, 04/18/2012 - 14:24 | 2355543 Nightblade
Nightblade's picture

Yeah, I remember listening to a CHK earnings conf. call a few years ago and Aubrey sounded like a jackass.  This news doesn't suprise me at all.

The same could be said for the CEO of Nvidia.

Wed, 04/18/2012 - 10:47 | 2354775 I think I need ...
I think I need to buy a gun's picture

The whole god damn country is corrupt, i can't believe its still functioning but there are signs of people losing all around

Wed, 04/18/2012 - 12:39 | 2355184 pemdas
pemdas's picture

Maybe if Aubrey bought his map collection back he could get a clue.

Wed, 04/18/2012 - 10:26 | 2354713 francis_sawyer
francis_sawyer's picture

Get drilled baby, get drilled...

Wed, 04/18/2012 - 10:30 | 2354725 Rainman
Rainman's picture

It's always easy to follow the rules when you make them up yourself.

Wed, 04/18/2012 - 10:36 | 2354740 Monedas
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Wed, 04/18/2012 - 10:32 | 2354732 Dr. Engali
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I tried to rehypothecate my kids so that I could buy AAPL on margin but the firm wouldn't take them. They did consider letting me rehypothecate their future labor until I pointed out the government already did that.

Wed, 04/18/2012 - 10:40 | 2354748 Monedas
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We've seen your kids !  Monedas  2012  Comedy Jihad Headstart Program

Wed, 04/18/2012 - 10:50 | 2354793 Monedas
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Where's Gene Marchbanks ?  Bring his black and blue anus to me !   Monedas  2012   FascismAnarchismSocialismCommunism = FASCism ! 

Wed, 04/18/2012 - 10:41 | 2354755 Buckaroo Banzai
Buckaroo Banzai's picture

So what the fuck is this clown doing with the $1.1 billion he has borrowed? Did I miss that in the article somewhere?

Wed, 04/18/2012 - 10:45 | 2354765 Tyler Durden
Tyler Durden's picture

do a text search for "Forbes"

Wed, 04/18/2012 - 11:41 | 2354887 MrPalladium
MrPalladium's picture

McClendon borrowed the money from various lenders to purchase fractional interests in gas wells from Chesapeake. If Chesapeake had given the fractional interests to McClendon, the grants would have been taxed at ordinary inome rates. By borrowing to purchase the interests, McClendon escaped taxation of the value of the interests, and could then deduct his share of the drilling and develoment costs against the income from the wells and then sell the fractional intrests and be taxed at long term capital gains rates if he held those interests for more than 12 months. Of course, if he loses money and cannot pay back the loans, any debt forgiveness will be taxed at ordinary income rates, forcing McClendon into BK unless he can cover the tax bill.

McClendon is one wild gambler and has committed the cardinal sin of being early, assuming he has not already sold his fractional interests and repaid the loans . Nevertheless, the ownership of fractional interests in the wells does keep his interests aligned with the shareholders, and guarantee that if CHK heads south, he will be battered far more than the common shareholders.

Below 17, CHK becomes an acquisition target.

CHK's  acerage is worth 3 times the current share price.

This is going to get interesting now that CHK is trading near the 2009 lows.

Wed, 04/18/2012 - 10:52 | 2354806 The Axe
The Axe's picture

firesale on gas assets

Wed, 04/18/2012 - 10:59 | 2354832 Monedas
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Yeah, but they raise the price of ass gaskets !  Monedas  2012   Comedy Jihad Fire In The Hole

Wed, 04/18/2012 - 10:56 | 2354820 Scalaris
Scalaris's picture

 

How is McClendon borrowing $1.1 billion by pledging his stakes in the company's oil & gas wells as collateral, through the three companies which he owned, listing Chesapeake's HQ as their address, and using those money to buy stakes in the very same oil & gas wells which were used as collateral for the borrowed funds, not compromising his fiduciary duty to Chesapeake investors, particularly when his biggest lender is simultaneously a major investor in two units of Chesapeake?

And also, how does this not constitute any type of SEC regulatory violation?

But most importantly, are those tiny drilling rigs on his tie? 

Wed, 04/18/2012 - 11:05 | 2354856 kekekekekekeke
kekekekekekeke's picture

he oozes class & sophistication

Wed, 04/18/2012 - 16:56 | 2356053 MrPalladium
MrPalladium's picture

The transaction has the same set of economic incentives as a stock option, with the critical difference that the CEO is at risk for the principal on the loan, gain on sale of the fractional interests and repayment of the loan is taxed as long term capital gain rather than ordinary income, and, unlike and option grant, the entire arrangement is non-dilutive.

From the shareholder's perspective, assuming that sale of the fractional interests is done at a fair price, what's not to love??

Frankly this hullaballoo looks like an effort to spike the common to a new low so that the smart money can buy. Notice that over 20% of the float changed hands today. Selling climax??

Disclosure: I bought some CHKDG preferred today for a long term hold and day traded the common for a small gain.

Wed, 04/18/2012 - 10:59 | 2354829 The Third Man
The Third Man's picture

So the powers-that-be are throwing us a bone. Wake me up when someone throws the book at a Goldman hack.

Wed, 04/18/2012 - 11:11 | 2354839 JW n FL
JW n FL's picture

 


@ 11:20(ish) you will hear why China is crashing.. it is because of the Savers! Larry Fink says so.. as well he says that China will not be able to rely on those moneys to Finance Growth.. so the Chinese Government will be looking to Scalp other Sectors to continue the Lie.. that is 10% (8% now is going backwards for China's debt service) Growth.

Polite people tend to skip over the fact that 10% growth for China is the Floor.. anything beyond that is structural decay.

 

 

 

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Wed, 04/18/2012 - 11:04 | 2354846 JW n FL
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as well! PLEASE SUPPORT!! http://www.dstressline.com/

Thanks!

Wed, 04/18/2012 - 11:06 | 2354852 kekekekekekeke
kekekekekekeke's picture

As an Okie this is juicy shit that I didn't know a lot about.  I see him at Thunder games and once I saw him with his entourage at a pub, he was totally obnoxious.  But uh, thanks for bringing us Whole Foods.

Wed, 04/18/2012 - 11:09 | 2354864 KandiRaverHipster
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EIG also gets a 42 percent cut of McClendon’s share of the well  profits “in perpetuity,” he said.

 
mang who agrees to that?

Wed, 04/18/2012 - 11:28 | 2354942 Trimmed Hedge
Trimmed Hedge's picture

Someone who has access to lotsa free money...

Wed, 04/18/2012 - 16:44 | 2356016 blunderdog
blunderdog's picture

Or someone who doesn't believe there are going to be any profits.

Wed, 04/18/2012 - 11:29 | 2354928 Monedas
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Street smart Colombian coke hookers get the drop on Obama's "Headstart" Secret Service agents !  12 Agents compromised for $47 !  Monedas  2012   Comedy Jihad Reimbursement Tour

Wed, 04/18/2012 - 20:41 | 2356788 StychoKiller
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'Tis the screwin' you get for the screwin' you got!

Wed, 04/18/2012 - 12:09 | 2355102 Lax Accounting
Lax Accounting's picture

This story is, at the least, almost a month old. See here: http://shale.sites.post-gazette.com/index.php/news/investigations/24415-mortgaging-the-future-of-natural-gas-chesapeake-energy-ceo-capitalizing-today-on-tomorrows-profits-in-west-virginias-farmland

Is the market broken this bad that the stock can hover for a month and then drop 10% on this news?

Wed, 04/18/2012 - 12:54 | 2355224 hettygreen
hettygreen's picture

Rolling Stone had some fairly unflattering things to say about Mr. McClendon and his business 'methods' over six weeks ago.

http://www.rollingstone.com/politics/news/the-big-fracking-bubble-the-sc...

Question: "Is the market broken this bad that the stock can hover for a month and then fall 10% on this (so-called) news?"

Answer: Yes and it's populated with tons of people who wouldn't know double entry accounting and signs of fraud if it bit them in the ass.

No sympathy for shareholders of this scam.

Thu, 04/19/2012 - 06:59 | 2357611 overmedicatedun...
overmedicatedundersexed's picture

I bought chk many years ago when it was sub $5.00 made a good ROI. but sold as this scum ceo talked of reducing debt while piling it on..growth thru debt and enriching himself and his good lenders..got out never looked back- this is no surprise and corzine could learn a thing or two from this turd.

Sat, 05/12/2012 - 00:47 | 2419440 MeelionDollerBogus
MeelionDollerBogus's picture

What a maroon. McClendon needed only to cash out some assets to have it in his name SOLELY and keep his margin trades ONLY to half what he could afford total net of all other trades.

Silly rabbit, trix are for kids.

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