babcock on ice

Babcock & Brown's latest deal with its bankers effectively puts the company into suspended animation while it sells assets to pay off its $3.25 billion in debts.

The company that in August boasted about lifting its assets under management from $11 billion to $77 billion in the four years to December 2007 will now shrink at a rate faster than it grew. The focus now is not on growing assets under management but reducing the $11.5 billion in liabilities.

The biggest asset disposal headache in the complex Babcock & Brown portfolio is the $4.6 billion property portfolio. At June this year it was carrying $2.97 billion in liabilities. Those debts might just be covered by property sales at realistic market values.

Babcock & Brown equity holders are facing a significant dilution of their interests because of the prospect of a debt for equity swap being negotiated between the company and its 25 banks by April next year.

The overnight debt for equity swap by UK fund manager New Star Asset Management is a sign of what can happen when banks give up on repayment and opt for equity. Shareholders in New Star were just about wiped out.

Debt for equity swaps are an attractive option for banks because it has less impact on capital. A loan that is written down causes a deduction of the same amount from tier-one capital. Whereas a debt for equity swap is spread across both tier-one and tier-two capital and the impact is limited by a equity investment allowance threshold.

Under the current rules laid down by the Australian Prudential Regulation Authority, banks do not have to make deductions against capital for equity investments that are less than 0.15 per cent of total regulatory capital. Above that level there is dollar for dollar deduction from total capital. As well, aggregate equity investments can not exceed 5 per cent of total regulatory capital.

Today's initial doubling in the Babcock & Brown share price to 50 cents shows investors think that only 90 per cent of the company's net assets of $6.20 a share will be wiped out through asset sales, impairments and equity dilution. That knee jerk assessment will probably prove to be too optimistic.

Holders of the company's $600 million in subordinated notes are facing several years without interest payments. Based on the old interest rate they are now trading on a yield of 200 per cent. However, no interest will be paid until the $150 million in fresh borrowings is repaid. That must be repaid by December next year.

The banks have used the provision of a new emergency facility to force Babcock & Brown to revisit its proposed restructuring plan announced on November 19. A new plan will be put to the banks by January 9.

Chief executive Michael Larkin today made no mention of his previous plan to keep Babcock & Brown's specialist infrastructure investment business.

Instead, he talked about “a revised business plan acceptable to its banking syndicate that will address the repayment of the short-term funding facility and form the basis of discussions to restructure the balance sheet".

Interestingly, the Babcock & Brown template description has been edited to exclude any mention of the company's operating divisions.

The new restructuring plan is likely to be more aggressive than the previous one which promised a halving in the $3.1 billion in corporate debt by 2011.

The bulk of the $2.6 billion in shareholders' equity in the Babcock & Brown balance sheet at June 30 is likely to be wiped out as a result of impairment charges from the deterioration in asset values.

Larkin and his team of advisors managed to win many concessions from the banks. The suspension of all financial covenants takes the heat off in the short term and allows the company to record huge write-downs in the half year to December.

The pay-if-you-can interest obligation on the $3.1 billion corporate facilities will allow more breathing space for assets to be sold. However, review clauses in the debt facility remain in place.

The agreement with HypoVereinsbank over a disputed $140 million deposit will remove the threat of default in the short term.

In putting Babcock & Brown into suspended animation, the Australian banks have protected their $800 million in loans and put off until another day the write-downs that will inevitably have to be taken when assets are sold at realistic market values.

Tony Boyd