Apples,This is a really hard one to answer. It's a big black box...

Apples,

This is a really hard one to answer. It's a big black box and we really don't know the full story.

In theory at least, a decreasing AUD should be positive for the company. A dollar of income earned in the US is worth a lot more in AUD terms now that it was at the end of the financial year. US properties are valued in USD which means that their equivalent in AUD has increased also.

Any interest or expenses on the US properties is paid in USD which removes FX risk on this part.

The complexities arise with hedging. Most people reading this will understand the mechanics of hedging, but just in case:

In a hedge transaction, a swap is agreed between two counterparties (C1 and C2) over a notional amount of an underlying instrument or rate. These are typically cash-settled at an agreed frequency, usually monthly.

For example, an interest rate swap. C1 borrows $1bn from a bank (say CBA) and pays a floating rate of interest on it, which for the purposes of this example is the RBA cash rate. C1 doesn't like the idea of a floating rate and wants to convert this (swap it) into a fixed rate (say 6%) to 'lock in' and protect against fluctuations. C1 takes out a swap with C2. C2 is in effect agreeing to to convert the floating rate (RBA cash rate) to a fixed 6%.

At the time the swap is taken out, C1 and C2 agree on a notional amount (which in this case is $1bn, but could be more or less). If the RBA cash rate drops, C1 pays less interest to CBA on their debt but has to pay the difference between the cash rate and 6% to C2. If the reverse happens, C1 pays more interest to CBA but C2 pays the difference to C1.

An FX rate hedge works the same way. C1 has an amount of money (say US$200m) in which it wants to protect against FX fluctuations against the AUD. It takes out an FX swap with C2 for a notional US$200m at an agreed rate, say 0.80. C1 and C2 cash settle the difference on the notional amount each month, the net result of which is that the US$200m is locked in at a rate of 0.80 for the duration of the swap.

When the world is happy and everyone loves each other, swaps work like a dream. But when the skies cloud over, things can go awry.

Swaps are over-the-counter agreements between counterparties and are not afforded the protection offered by a regulated market. That means C1 and C2 have to trust each other to be able to cash settle the difference. This is called counterparty risk. One side is usually a major financial institution and if they stop trusting the ability of the other side (usually a company) to pay they will either stop transacting new deals, or ask for collateral to support existing deals. In extreme cases, they may look to close out the swap.

Centro has a number of problems. Firstly, they offer major counterparty risk which means that they have had trouble transacting new swaps. As old swaps expire, they ain't being renewed. Secondly, the counterparties are undoubtedly asking for more collateral on existing swaps which simply saps assets or cash.

Adding to the woes is another subtlety of the Centro empire: there are related-party swaps in the Centro group. This means, simply, CNP has taken out swaps with Centro entities, such as CER. C1 = CER, C2 = CNP. This means there is inter-group exposure and the need to, notionally at least, cash settle between Centro entities. Messy.

As you will see on p29 of the YE results presentation, CNP outlined the IR (interest rate) and FX hedges it has in place with internal (related party) and external entities. They went to great lengths to prove that the hedge book had improved between YE and Aug 15th as you will see. Messy, messy, messy.

So, where do we stand today? In the half-year results, (p32 of the half year presentation) which seems to be the latest disclosure, Centro had US$3.540bn of FX exposure hedged and US$933m unhedged (note the comment on bullet point 2). This means that any movement on the first $3.540bn will have no net effect on the company but the remainder will be positive as the US$ improves.

As for IR hedging, Centro disclosed that US$3.7bn of debt (excluding SuperLLC) was hedged at an average rate of 6.52%. As interest rates have dropped, if the lender has passed on the drop to CNP on the variable rate loans, the position will have improved. BUT, I hasten to add that Centro said that the debt extension were done with no increase in interest rate, which could also mean no decrease in rate too.

Trying to unravel this is, I believe, impossible for shareholders. To counter this, I have taken a simple approach when considering the problem. Firstly, the loans on US properties are in US$. Interest and asset sales will be in US$ which means the only time we need to think FX rate is when income or loss is repatriated back to the mother ship in Oz. With the AUD dropping against the USD, we are in positive territory for the time being at least. Secondly, there has been no increase in interest rates payable on Centro debt so the interest component has not changed materially. Thirdly, I assume that the external counterparties to Centro swaps are either banks involved in the refi process OR instos that will have made a point of taking a detailed look at the Centro position in the last year and are therefore (reasonably) comfortable with the situation. Finally, if a related-party swap turned to custard, the Centro 'group' would work through how to solve the problem.