End of the road for Babcock & Brown?

A huge question mark hung over the survival of Babcock & Brown late last week after the company requested a trading halt in its shares following a dispute with one of its banks.

The trading halt is expected to remain in place until the resolution of the dispute, which has threatened to derail the borrower’s restructuring plans, and could ignite a mad scramble by lenders to protect their money.

B&B requested a trading halt on November 20, just one day after unveiling a new business plan involving huge job cuts (or, in their words, “increased head count reduction”), saying it was mired in a dispute with a bank over a “deposit amount”, and the “release of that deposit”.

The lender in question is believed to be HVB, and the amount A$150m. HVB is one of 26 lenders to B&B.

Bankers say the lender may have exercised its “right of set off”, by which it has frozen cash deposited by B&B. The bank took this action to offset potential losses it would incur if it did not recover 100% of its loan to B&B.

The disclosure has raised concerns that cracks are appearing in the consensus among lenders required to sustain their financial lifeline to B&B.

“When one bank starts doing this it does suggest that everyone else will start doing the same,” said a market watcher.

B&B is desperate to avoid going into voluntary administration like former rival Allco Finance Group, which threw in the towel earlier this month when its lenders failed to agree to yet another debt restructuring.

B&B on November 19 asked its 26 banks to relax loan covenants linked to A$3.1bn (US$2bn) of debt.

“With new business activity having slowed materially in recent months, our new forecasts suggest the group’s interest coverage could breach a debt covenant either this year or next. Against a covenant of three times, we now forecast interest coverage of three times in calendar year 2008 (estimated) and 2.4 times in calendar year 2009 (estimated),” wrote Citi equity analyst, Mike Younger, in a research report dated November 17.

Following the November 19 announcement, S&P downgraded B&B to CCC+ from BB–, citing the increased risk of breached loan covenants leading to lenders demanding accelerated repayment of debt. The ratings agency also highlighted the difficulties of pursuing asset sales in the current market climate.

On November 21, after news of the bank dispute emerged, S&P downgraded the credit again to CC from CCC+, and placed the borrower on CreditWatch with negative implications. CC is the lowest rating that S&P will apply to a company that has not actually defaulted on any debt.

B&B hopes a new corporate restructuring exercise will give some comfort to lenders. The company said it would cut staff by 59% to 600 by 2010, through redundancies and asset sales. It will also refocus on its infrastructure business and put up for sale its real estate and operating leasing businesses.

Given B&B’s increasingly tenuous access to fresh funding, most perceive the restructuring exercise as a euphemism for a winding down of operations. But lenders are in a dilemma. On the one hand, keeping the company afloat and controlling the timing of asset sales increases their chances of getting all of their money back. On the other hand, delaying sales may well see the company flogging assets into an ever deteriorating market.

“We see considerable value downside in real estate and operating leasing,” wrote Merrill Lynch research analyst Kieren Chidgey on November 19.

“In addition, although B&B has not previously marked-to-market its listed funds, with these now trading A$630m below book and as the only player not marking its funds we see limited scope for this practice to continue. As a result, second-half 2008 write-downs could significantly exceed the A$440m in first half of 2008, materially impacting operating PBT [profit before tax] which could see debt covenants breached.”

B&B shares were quoted at A$0.25 before trading was suspended on November 20. This is from an all-time high of A$33.78 achieved on June 22 last year.

Investors have lost confidence in companies such as B&B and Allco, which share the same complex and opaque relationships between satellite funds and parent, heavy use of leverage, and steep management fees.

Lenders on an A$2.8bn revolving syndicated loan facility, which forms part of the combined debt, include ANZ, Banco Espirito Santos des Orients, Bank of America, Bank of Ireland, Barclays Capital, BayernLB, BNP Paribas, BOS International, Calyon, Citi, Commonwealth Bank of Australia, DBS Bank, Dexia Bank, HSH Nordbank, Hypo Public Finance Bank, HVB, KfW, Millennium Bank, nabCapital, OCBC Bank, SG, Suncorp-Metway, UBS, United Overseas Bank, WestLB and Westpac Banking.