In an emergency meeting scene from the 2011 movie “Margin Call” which depicted an investment bank suddenly realising the enormous amount of bad mortgage-backed loans held on its books, the CEO character John Tuld (played by 1990 Academy Award Best Actor Jeremy Irons) asked his team: “Do you care to know why I’m in this chair with you all? I mean, why I earn the big bucks….I’m here for one reason and one reason alone. I’m here to guess what the music might do a week, a month, a year from now. That’s it. Nothing more.” [Click here to watch a 9-minute clip of the emergency meeting scene in “Margin Call”, with performances by Jeremy Irons and Kevin Spacey as his head of trading division.]
(1) MAMA ALWAYS SAID LIFE WAS LIKE A BOX OF CHOCOLATES, NO?
The above statement from that movie may be exaggerated, but certainly, providing foresight and vision should be a substantial part of, if not the only reason for, earning the big bucks. If we can agree on this, then it was a big surprise to me when DBS Group Holdings’ (“DBS“) CEO Piyush Gupta — the highest-paid local bank CEO for 2015 — admitted that he was surprised by Swiber’s development since late May. According to the Straits Times report published on our National Day and headlined “DBS caught off guard by Swiber’s swift implosion” (the “ST Report”), Gupta explained that “Swiber imploded in six weeks…This thing unravelled between late May and mid-July. So when people say you should have known, none of the indicators showed it“. Now, Gupta should be forgiven for being surprised by Swiber filing for liquidation instead of the less drastic judicial management — we all were. But if the word “implosion” meant Swiber’s cash flow problems coming to a head by or around mid-2016, then this implosion was very well flagged in advance by, among others, a few indicators (e.g. the company’s limited cash flow from operations, slowing trade receivables turnover since 2011 and particularly its daunting medium-term notes repayment schedule — see my earlier article on Swiber titled “Swiber’s liquidation: 7 things we learn”), and even a 96-page oil and gas sector research report issued by none other than DBS Vickers Securities on 18 September 2015 titled “Drilling deeper for the gems” — see pages 15-18 of that report.
(2) WHAT IS DBS’ EXPOSURE TO SWIBER RIGHT NOW?
The above is an extracted Powerpoint slide from DBS’ media briefing on 8 August 2016, with the full briefing webcast being available here on the bank’s website. If there is some consolation from these unfortunate loans to Swiber, it is that the S$403 million of loans were provided as working capital for only two projects, and these loans are secured by, among others, a “charge on certain trade receivables” — per page 98 of Swiber’s 2015 annual report. The two risks on these working capital loans are therefore (i) execution risk, although one project is already 80% completed while the other is 50% completed according to Gupta; and (ii) counterparty risk, i.e. risk of not receiving payment from the customers of these two projects. The potential for counterparty risk along the entire offshore oil and gas industry chain is uncertain and cannot be overemphasized, unless you think that cash flow problem is an isolated one unique to Swiber only. In any case, this S$403 million of working capital loans appear ring-fenced. This leaves us with the S$197 million loan extended to Swiber to redeem the two medium term notes which matured on 6 June and 6 July 2016 — what I’ll denote as the “Additional Loan” to be discussed in point (4) below.
(3) IS BEING “CONSISTENT WITH MARKET” GOOD ENOUGH?
In this second extracted Powerpoint slide, Gupta explained DBS’ decision for not having classified its loans to Swiber as being a “Non-Performing Asset” or “NPA” much earlier. One of the considerations was that DBS had checked with other competitor banks (i.e. UOB and OCBC), on a quarterly basis, if they had classified their loans to Swiber as NPA already. As the other banks had not yet done so, therefore DBS was being “consistent with market” in not doing so either. Now I’m tempted to question whether such peer comparison is an effective component of a sound, independent-minded, anticipatory and market-leading basis for deciding if a loan should be a NPA or not — or for any financial decision for that matter. (I accept that my view on this peer comparison practice may be disputable, given that my background was in investment banking and not corporate lending.) Furthermore, this type of argument becomes circular if the few banks all start looking at one another like a herd, waiting for another to take action before following suit. Being “consistent with market” should not become a case of “I’m not okay, but if others are not okay too, then I’m okay“. And by the way, DBS might have noticed in the course of their peer checks that OCBC has no exposure to Swiber, as reported by the Business Times on 28 July 2016.
(4) SHE’LL BE COMING ROUND THE MOUNTAIN: WHAT’S WITH THIS SIGNED PREFERENCE SHARE SUBSCRIPTION AGREEMENT?
According to the ST Report, Gupta defended that the bank’s decision to extend additional S$197 million loans to the company was based on two key factors, the first of which was “the expectation of a US$200 million (S$270 million) cash infusion that was supposedly coming from London-based private equity firm AMTC, which had expressed interest in investing in Swiber.” By the way, this supposed cash infusion from private equity was also one of the abovementioned considerations for not classifying its Swiber exposure as a NPA earlier. Gupta described this decision to make the Additional Loan as a “classic banker’s dilemma: do we put in more money to recover more or not?”
With the benefit of hindsight, it is easy and perhaps unfair for us to criticize DBS’ decision with various “you should have”, or to suggest that DBS should not have thrown good money after bad and should have just let Swiber fall into judicial management back in May. “This is the bank we are, we don’t pull the plug on customers,” Gupta said, and certainly with some empathy from anyone used to Bob Hope’s joke that “a bank is a place that will lend you money if you can prove that you don’t need it”. This is especially when DBS had done their own tire-kicking by, among others, having spoken with AMTC’s CEO Smith O’Connor and also seen that AMTC had engaged EY, Deloitte and a big law firm to perform substantial due diligence work on Swiber —- although you can make your own judgment on whether these checks are sufficiently reliable indicators of comfort. It should also be noted that DBS still has a healthy balance sheet with non-performing loan ratio of only 1.1% and generous provisioning made during good times.
Having balanced all these, one key takeaway from this AMTC saga is that we have to be very careful about relying on so-called “expressed interest” or “proposed investment” (the words used in a Straits Times report dated 4 August 2016), which may or may not lead to actual cash infusion. In his media briefing, Gupta mentioned a legally binding subscription agreement being signed on 9 June 2016 between Swiber and AMTC. Now admittedly, I am not privy to the detailed terms and conditions in this preference share subscription agreement. Nevertheless, it is widely found in such type of agreements that final completion after signing (i.e. handing over of the money by AMTC as agreed upon) is typically premised on the conditions that there is (i) a satisfactory due diligence finding on Swiber by AMTC’s consultants; and (ii) no “material adverse change” occurring to the borrower between signing and completion — what lawyers like to call the “MAC clause”. In any case, and in spite of a recent Business Times report that said AMTC was still keen on the investment, one should have been (and should still be) highly sceptical of AMTC being willing to come to Swiber’s aid —- and DBS’ aid too — as merely a preference shareholder, which ranks below a bondholder and only ahead of the ordinary shareholder in the hierarchy of claims on the borrower during liquidation. In terms of hard, sale-able assets to offer as security, one may now be scrapping the barrel to find sufficient unencumbered assets to back a US$200 million loan from AMTC, given that the majority of Swiber’s Property, Plant and Equipment may have already been pledged to DBS. Another possible takeaway is that lenders should do better to really anticipate well ahead and work proactively with the borrowers to reorganize their finances much earlier, given that the time frame to complete a proper balance sheet restructure can exceed 12 months as the various stakeholders always have different agendas that have to be aligned. This is a point raised by Mr. Kurt Metzger, a Singapore-based director at GEM Advisory.
THREE WAYS TO MAKE A LIVING
I like to end by quoting again from the movie “Margin Call” wherein the CEO character John Tuld said: “There are three ways to make a living in this business: be first, be smarter, or cheat.” Now I am certainly not advocating nor condoning anyone to cheat, but DBS shareholders may feel entitled to question how their management fared on the first two counts, particularly when their bank now has the highest level of both absolute and percentage-of-loan-book exposure to the oil and gas sector among the Big 3 local banks — according to a report published by Singapore Business Review on 13 January 2016. Their questions at the next AGM may be harsh, but it comes with the territory of being a listed company.