Glencore: credit default swaps suggest something amiss

You have probably never heard of Glencore. Well you have heard of its founder Marc Rich, the man infamously pardoned by President Clinton before he left office. And I suspect that you will soon hear a lot more about the company as well.

Glencore is a metals production and trading company based in Switzerland. It is one of the largest privately-owned companies in the world and a very large employer in Switzerland. The problem is that commodities prices have been absolutely decimated. So, the secretive Swiss company’s credit default swaps are trading at huge premiums, something we alluded to last month.

The obvious question is: why is that? Unfortunately, the answer is: nobody knows. But rumors of financial problems are mounting.

Glencore announced on Tuesday that it was considering a debt buy-back after the cost of insuring against its default rose to a level that did not reflect its financial situation, the world’s largest commodities trader said.

The decision by the secretive Swiss-based group came hours after Standard & Poor’s, the rating agency, downgraded Glencore’s long- and short-term credit rating to BBB-minus and A-3 respectively, down from BBB and A-2. The outlook is “stable”, S&P said.

Glencore’s credit default swap spread reached a record high last week. From a level of less than 200 basis points in early September, it rose to more than 3,100bp, meaning it cost more than €3.1m ($4.1m) annually to protect €10m of the firm’s debt over five years.

“Glencore strongly believes its current credit spreads do not reflect its underlying credit profile, and has therefore decided to utilise part of its strong liquidity position to selectively consider debt buy-back opportunities,” it said in a statement.

The company did not say how much debt it planned to buy back.

Glencore said that its current liquidity, both cash and undrawn banking facilities, exceeded $3.5bn. It added that lower commodities prices were reducing its working capital needs and estimated that this natural deleveraging would result in another $2bn of spare liquidity by the end of the year. S&P estimated Glencore’s short-term debt for 2009 at about $2bn.

This seems like a case where the external business environment is declining rapidly, yet the company paints a pretty picture of its finances. But, no one really knows what’s happening inside. They can only speculate based on publicly available data. And that data is not good.

Glencore, which is controlled by its employees, trades base metals, minerals, oil and agriculture commodities. It also owns smelters and stakes in mining companies, such as 35 per cent of miner Xstrata.

S&P said it had cut its view on the Swiss trader because of “metal prices’ unprecedented fall and weak near-term outlook” and “the related significant drop in the value of Glencore’s industrial investments portfolio, which has resulted in weaker asset-debt coverage levels”.

The market value of Glencore’s 35 per cent stake in Xstrata has, for instance, shrunk to about $3.7bn from around $22bn at the end of June.

Stay tuned.

Sources
Glencore considers debt buy-back – Financial Times