good comment from Stephen Bartholomeusz......mmmStephen...

good comment from Stephen Bartholomeusz......mmm


Stephen Bartholomeusz

Published 11:53 AM, 2 Dec 2010


One of the more curious developments of recent months has been the steady exit, at big discounts to the face value of their loans, of Centro Properties Groups bankers.

The curiosity is not that the banks Australian and foreign have been prepared to take brutal haircuts on the loans, but rather that anyone has been prepared to buy that debt, given that Centro Properties has a deficiency in its security holders funds of $2.1 billion.

The early sales (RBS and Germanys West LLB among them) were at less than 50 cents in the dollar. CBA sold about $110 million of its exposure last month for a reported 56.5 cents in the dollar. Only a week or so ago ANZ sold $700 million of its Centro exposures for 63.5 cents in the dollar. The values are creeping up.

For the sellers, which presumably had previously provided for losses on their loans, the sales release cash and, depending on the extent of their provisions, potentially could result in some write-backs.

The buyers of Centros debt are hedge funds. Why would they want an exposure to an entity that has nearly $19 billion of liabilities and only $16.8 billion of assets? They are buying because from their perspective, with a little bit of help from Ben Bernanke, the maths looks very attractive.

The funds, thanks to QE2, can borrow in the US at negligible interest rates. The most recent Centro refinancing was done at a fixed rate of 6.75 per cent, so there is a very positive carry just on the yield and, of course, those funds that bought Centro debt below 50 cents in the dollar would more than double the yield.

The fund that bought debt at 43 cents in the dollar, for instance, would be generating an effective yield of 15.7 per cent, while at 63.5 cents in the dollar the effective yield would be a still attractive 10.6 per cent, providing a nice carry trade given that the US funds can probably borrow at less than two per cent.

Given the size of the deficiency in Centro, buying its debt is not without risk. But by buying at a discount the funds are steadily reducing that risk. If all Centros debt were notionally valued at 63.5 cents in the dollar, for instance, it would have positive net assets of about $4 billion.

The more of the debt the funds control the less likely it is Centro will end up in some form of insolvency administration and the more likely it is that it can be reconstructed and that as well as the big positive carry on the yield the funds will recover much of the face value of the debt. The exercise could be fabulously profitable for the funds.

Controlling Centros debt would also give the funds a big say in its future. The Centro groups underlying property portfolio has held up pretty well. The Australian portfolio is in very good shape and while it took a hit from the financial crisis, the US portfolio appears to have stabilised.

The underlying condition of the portfolios could provide extra upside and the funds not only have an important seat at the table but privileged access to information.

The Centro group has started the process of trying to reduce its debt by putting $12 billion to $13 billion of properties up for sale, a process that appears to have attracted a lot of interested parties.

The hedge funds might see an opportunity to be involved in the sales process or to participate in a subsequent recapitalisation of Centro Properties and the restructuring of the broader group.

Earlier this year a group of about 40 hedge funds, private equity funds and specialist distressed debt funds holding as much as 60 per cent of Alintas debt were involved in a recapitalisation that included a debt-for-equity swap.

Buying the debt of an entity with negative net assets might appear risky, but the Alinta experience, and the interest in Centro, would suggest that these kinds of complex distressed debt situations in groups where the underlying assets are attractive can create layers of opportunities to generate profits, with the risks dramatically reduced by the haircuts taken by the departing traditional bankers.