babcock n brown debt covenants in focus

By Rebecca Thurlow
Of DOW JONES NEWSWIRES

SYDNEY (Dow Jones)--Babcock & Brown Ltd. (BNB.AU) is meeting its key debt covenants but economic
weakness in Europe and the U.S. would increase risks of a breach by crimping cashflows within the
firm's assets, analysts said Friday.
Debt covenants are in focus as the market assesses the ongoing viability of the troubled asset managed firm that has been hit hard by fallout from the global credit crunch.

Babcock & Brown Thursday announced a management overhaul and restructuring plan in an attempt to restore investor confidence after a 30% first half profit fall, asset writedowns and a 92% share price fall since the beginning of the year.

In its presentation on the changes, the firm revealed its net asset cover ratio was at 2.1-times at June 30. Asset cover is a measure of a firm's solvency or ability to pay back its debt and is usually expressed as a ratio of balance sheet assets to long-term debt.

A Babcock & Brown spokeswoman said Friday that the covenants on the firm's corporate debt facility are that the firm maintains a net interest cover ratio of more than 3.0 times, net asset cover of more than 1.8 times and rolling net profit of more than A$200 million.

ABN AMRO analysts said the firm's net asset cover ratio is not too far off the minimum 1.8-times level required under the firm's corporate debt facility.

To be sure, ABN AMRO analysts calculate that writedowns in the second half of 2008 would need to be around A$800 million - almost double those in the first half - before the net asset cover ratio drops below 1.8 times.

That's unlikely, they say, forecasting writedowns of A$220 million in the second half, but possible if weakness in the economies of Europe and the U.S. crimp cash flows at the firm's investments.

"Management stated that the net asset values are dependent on discounted cash flow valuations," the ABN AMRO analysts said.

"We argue that both Europe and the U.S. are heading into difficult times and that cash flows are likely to be impacted significantly over the next year.

"In our view, it is the potential for economic deterioration, rather than a substantial increase in the cost of debt or the fall in real estate prices, that could be the catalyst for Babcock & Brown to breach its covenants."

The firm's net interest cover, at 5.3 times at June 30 according to the spokeswoman, is not so close to the 3.0 times debt covenant. The ratio - calculated by dividing earnings by interest payments - measures the extent to which earnings are available to meet interest payments. The higher the ratio, the better.

However, Merrill Lynch said Babcock & Brown could breach its net interest cover covenant if its second half operating profit is below A$145 million.

That would be a fall of 31% from A$211 million a year earlier and is "unlikely, but not impossible," said Merrill Lynch analysts Kieren Chidgey and Naveen Patney in a report.

"We estimate this is only likely under a combination of significant events such as European wind sales failing to proceed along with a further writedown of about A$500 million in assets," they said.

Babcock & Brown was forced into talks with its lenders in June after a dramatic fall in its market capitalization gave the financiers the right to review the firm's A$2.8 billion corporate debt facility. The firm was given a reprieve later that month when the lenders removed the market capitalization clause attached to the facility and waived their right to review Babcock's ability to repay the debt. To secure the deal, Babcock agreed to an increase in the margin on the debt and agreed to pay it down by around A$400 million through previously announced asset sales. The 25-member banking syndicate includes Australia's big four banks - National Australia Bank Ltd. (NAB), Commonwealth Bank of Australia (CBA.AU), Westpac Banking Corp. (WBK) and Australia & New Zealand Banking Group Ltd. (ANZ). HBOS PLC's BOS International (Australia) Ltd. is the agent on the syndicate, and a large proportion of the syndicate is made up of European banks including Deutsche Bank AG (DB).

After falling to a record low of A$1.96 in early trade, Babcock & Brown shares took a breather from their recent rout, rebounding with the help of a report from Standard & Poor's that reaffirmed the agency's rating on subsidiary Babcock & Brown International Pty Ltd. The parent company is unrated by Standard & Poor's.

At 0545 GMT, Babcock & Brown shares were up 22 cents, or 9.9%, at A$2.44, outperforming the overall market, which was up 1.2%.

Credit rating agency Standard & Poor's reaffirmed its BB+ long-term rating on Friday, saying it wasn't surprised Babcock had to make impairment charges against assets and investments in the current market environment.

"The changes in the board and senior management are a positive move for implementing the next stage in the evolution of Babcock & Brown Ltd.'s, and thus Babcock & Brown International's business model," said Standard & Poor's credit analyst Ian Greer.

"This change has been and will be assisted by B&B Ltd.'s stoppage of dividends, decline in employee bonuses, and planned reductions in debt and staff headcount," Greer said in a statement.

However, Greer warned that in this transition period for the strategy and into the immediate term, Babcock & Brown International remains exposed to initial project valuation, development, operating, and financing risks.

"The capital structure is still complex, and uses debt leverage at the corporate, asset-specific, and managed funds levels," he said. "These risks are partly mitigated by the company's approach to risk-return management and its practice of financing assets mainly through nonrecourse debt."


-By Rebecca Thurlow, Dow Jones Newswires; 61-2-8235-2959; [email protected]