Ann: Fortescue announces multi-billion dollar refinancing, page-32

Karasco,

Sorry about the tardiness of my response.

I'm an ex-treasurer (not of FMG) so I know a fair bit about bonds, debt and managing refinancing risk.

The accounting treatment for debt is normally on a straight line basis, which means that as they issued the bonds at par ($100) initially, the interest expense each year through the P&L was simply the interest they paid out in any given financial year.

The bonds they are buying back are being bought back at a premium, meaning for more than $100 face value. This is a loss as they sold something at $100 and are buying it back at $103. This loss will be treated as an abnormal on their P&L and not as part of the core operating business.

So when they issue the new bonds at a lower rate, they can claim that they have lowered their interest expense. However, in reality, the old interest expense on the 4 years remaining of the 2019 bonds equates to the sum of the premium they are paying to buy back the 2019 bonds PLUS the new interest expense on the new 2021 bonds. (Note - this is a simplistic view - it is a bit more complicated but only marginally different).

So when you see FMG's next profit announcement, they will state that that they have reduced their operating costs via interest expense, but will also have an abnormal for the loss on refinancing these bonds early.

As I said in an earlier post, they are buying insurance to ensure they have much more time to manage any further deterioration in the iron ore market - a smart move by the company.

Happy to help if you have any other questions.