One week ago, as confirmation that the recent oil rally is merely being used by banks to force debtor companies to sell equity and to repay as much secured loans as possible, we showed the case study of Weatherford International and its primary banker, JPMorgan.
As we laid out, Weatherford had been in talks with JP Morgan Chase, its key lender, to re-negotiate its revolving credit facility - the only thing keeping the company afloat. "However, in a move that shocked the financial markets, JP Morgan led an equity offering that raised $565 million for Weatherford. Based on liquidation value Weatherford is insolvent. The question remains, why would JP Morgan risk its reputation by selling shares in an insolvent company?"
"According to the prospectus, at Q4 2015 Weatherford had cash of $467 million debt of $7.5 billion. It debt was broken down as follows: [i] revolving credit facility ($967 million), [ii] other short-term loans ($214 million), [iii] current portion of long-term debt of $401 million and [iv] long-term debt of $5.9 billion."
But the biggest surprise was that JP Morgan is also head of a banking syndicate that has the revolving credit facility.
It was a surprise because JP Morgan also happened to be the lead underwriter on Weatherford's equity offering.
The punchline: the proceeds from the offering are expected to be used to repay JP Morgan's revolving credit facility.
Our friends from the New York Shock Exchange summarized this circular cash flow best:
"in effect, JP Morgan is raising equity in a company with questionable prospects and using the funds to repay debt the company owes JP Morgan. The arrangement allows JP Morgan to get its money out prior to lenders subordinated to it get their $401 million payment. That's smart in a way. What's the point of having a priority position if you can't use that leverage to get cashed out first before the ship sinks?"
We explained the market implications from this as follows: "as a result of this coordinated lender collusion to prop up the energy sector long enough for the affected companies to sell equity and repay secured debt, the squeeze may last a while; as for the bad news: the only reason the squeeze is taking place is because banks are looking to get as far from the shale patch and the companies on it, as possible."
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But while the Weatherford example was indeed grotesque and extreme in its inherent conflicts of interest, some readers wondered if this was perhaps an isolated case. The answer: a resounding no.
Here is Credit Suisse' James Wicklund with the detail:
We have been paying close attention to E&P equity raises over the past few weeks, looking specifically at the size and proceeds of the deals. So far in 2016, NAM E&Ps have raised $9.3B in equity, down from $16.0B for full-year 2015. Proceeds are similar to 2015 as E&Ps proceeds are going to pay down debt and, in some cases, fund capex.
... but mostly to pay down debt, and almost exclusively secured, revolver debt as the following table shows.
Which goes back to what MatlinPatterson's Michael Lipsky said some time ago: "we always assume that secured lenders would roll into the bankruptcy become the DIP lenders, emerge from bankruptcy as the new secured debt of the company. But they don't want to be there, so you are buying the debt behind them and you could find yourself in a situation where you could lose 100% of your money."
For the answer why banks are scrambling to get out, ask the Dallas Fed.
And since the Dallas Fed won't answer, the question remains: if the secured banks "don't want to be there", why are new unsecured equity investors so desperately eager to take their place, and just what do the banks know that these new equity buyers clearly don't?