Down Under Feels the Subprime Crisis, Too

Centro Properties, Australia's second-largest shopping center manager and owner, has been plagued by debt problems due to U.S. financial woesand the contagion is spreading

Investors in Centro Properties, the fifth-largest owner and manager of U.S. shopping malls, could hardly have imagined a worse end to 2007. In mid-December, Centro, Australia's second-largest shopping center manager and owner, emerged from a four-day trading halt with news it was struggling to refinance its debts—$1.14 billion in long-term debt and $1 billion in joint-venture debt—after traditional finance options dried up because of the U.S. subprime crisis. The stock plunged 80%, losing $3.5 billion in value and making it the worst performer of the 200 largest companies in Australia.

The news keeps on getting worse. In an after-market announcement on Jan. 4, Centro revealed it would not be able to maintain interest-rate hedging, which could reduce earnings. This sent the stock tumbling a further 15% when it opened. Trading in the shares were again halted on Jan. 11 pending a further announcement about the futuer of the company, which is facing the possibility of multimillion-dollar lawsuits over its alleged failure to disclose more than $880 million in debt. Centro had allegedly reclassified the debt as non-current liabilities in its 12-month accounts to June 30, 2007, masking a $396 million funding hole in accounts.

When contacted, a Centro spokesperson declined to comment. The company is reported to have been questioned by Australian regulators about its debt accounting, and may face further action. Over the weekend, company executives were locked in meetings with financiers to discuss ways out of the crisis.

A Dramatic Collapse

Whatever they decide, they need to work fast. Centro, which has around 700 U.S. properties—the largest being Independence Mall in Wilmington, N.C., Cortlandt Towne Center in Mohegan Lake, N.Y., and Pointe Orlando in Orlando, Fla.—has until Feb. 15 to refinance $2.4 billion in debt relating to its U.S. shopping center business or come up with an alternative plan that satisfies its lenders. It must also refinance $1.1 billion in its affiliated Australian Centro Retail fund by the same date.

The Centro collapse has been dramatic. Based in the Melbourne suburb of Glen Waverly, the company owns 124 shopping centers in Australia and had been on a $9 billion U.S. spending spree in the past two years. That included the acquisition of mall owners and managers New Plan Excel for $5.9 billion and Heritage Property Investment Management for $2.1 billion. These acquisitions helped Centro's funds under management rise from $8.7 billion to around $23.4 billion in just two years. But they also added debt of $1.5 and $1.4 billion, respectively, to a company whose total debt is now estimated at $15.8 billion. Of the 700 Centro-owned shopping centers in North America, 470 were acquired as part of the New Plan Excel purchase ast April.

Those malls, in 40 states such as Pennsylvania, Connecticut, and Texas, are now weighing down Centro because of the high levels of debt the organization took on to acquire them and the higher cost of new debt due to the subprime crisis. In a presentation to analysts on Dec. 17, Centro Chief Executive Andrew Scott said it has been the company's policy to manage debt and interest rate risk by utilizing short- and long-term debt maturities, and sourcing debt from international markets, including those in the U.S.

Death of a Brand

Over the past five years ending in June, U.S. commercial mortgage-backed securities issuance has been more than $80 billion a month, but that flow has now dried up due to the subprime crisis. "We never expected, nor, we believe, could have reasonably anticipated, that the sources of funding available to us and many similar companies would [be] shut for business," Scott said at the analysts' briefing.

As a result, Centro is now on the block. Potential buyers have remained quiet, although it is likely there will be an announcement before the Feb. 15 deadline set by the company's creditors. Scott has already indicated that to get new financing Centro will need to reduce its debt, which is likely to lead to a sale of assets. Analysts suggest that as a brand, Centro is almost certainly dead—the question now is who will buy which parts of the company or whether a single buyer will emerge.

The complex ownership structures within Centro, high levels of debt, and poor disclosure make it difficult to determine what the true value of the group and its assets would be. According to Merrill Lynch (ML), the little-to-no equity value left in Centro New Plan if it is repriced to market value means the main source of equity for the group is likely to come from its Australian assets and funds business, for which buyers may be willing to pay near-market valuations.

Not All Bad News

Merrill has rated as likely buyers Australian Stock Exchange-listed Colonial First State (CFS), Retail Property Trust (managed by the Commonwealth Bank of Australia, and Sydney-based real estate investment trust GPT, followed by the property developer Stockland, also from Sydney, which has properties across Australia, New Zealand, and Britain. Another leading contender is Westfield Holdings, the world's largest retail property group by market capitalization. The Sydney-based Westfield already has 9,000 retail outlets in the U.S., and last month formed a joint development partnership with the Port Authority of New York & New Jersey to develop the retail facilities at Ground Zero's World Trade Center redevelopment site in downtown Manhattan.

The news isn't all bad for Centro. While the U.S. economy is teetering on the brink of recession, growth in Australia remains healthy. The company's Australian retail assets in particular have been strong performers and are likely to realize much of their value in a sale.

Default is Worst-Case Scenario

Still, there is significantly less value in the company's wholesale funds and U.S. assets. That's likely to keep the sale price under $0.88 (AUD$1.0) per share. The last trade was at $0.77 (AUD$0.88). Credit ratings agency Standard & Poor's (like BusinessWeek, part of McGraw Hill (MHP)) estimates total debt for the group of 71%. On Jan. 3 it downgraded its risk assessment on $865 million of unsecured debt in Centro New Plan to junk status, from its previous BB+ rating.

S&P's director of corporate ratings, Craig Parker, says this previously healthy fund has now been dragged down almost to default because of leveraging by the parent. "The worst-case scenario is that it does default on Feb. 15, but if the banks do agree to the restructuring plan the group is proposing, potentially this very healthy fund would survive and would continue to keep paying its interest, and roll over its short-dated bank facility," Parker says.

Even USB (UBS), which was a strong promoter of Centro prior to the announcement of its problems, has joined in the stock sell-off, with UBS Global Asset Management reducing its holding from 6.32% to 5.26%, after an earlier sale of 2.31%. UBS had previously bought $16.7 worth of Centro shares on Dec. 19—just days after the first announcements.

Anticipating Widespread Effects

Centro isn't the only Aussie property company suffering subprime blues. Even before that company's fall, Australian home mortgage lender RAMS Home Loans Group self-destructed in spectacular style in August (just weeks after issuing stock on the Australian Stock Exchange) after failing to refinance $5.4 billion in debt. The company had raised funds using short-term commercial paper loans from the U.S .market, a source of funding that has dried up during the subprime crisis.

RAMS Home Loans subsequently sold its brand name and distribution business to the Westpac Banking Group for $123 million. Concerns about the fate of Centro and the effect of the global credit crunch on other Australian listed property stocks, particularly the rising cost of financing, has wiped a total 20% of the value—around $19 billion—from the 20-largest Australian-listed property stocks, including Westfield. A report from the senior analyst for Australian property research at Merrill, John Kim, rated Centro as a sell with significant trading risk.

However, despite the obvious black eye Centro has dealt to the listed property trust sector, Kim does not expect similar disasters are waiting in the wings. But, he says, many companies should "vastly improve" their information on debt disclosure. "We view [these] events as a reflection of a number of characteristics that in aggregate are unique to Centro, although there are other companies that share some similarities."

Spreading to Banking Sector

The subprime contagion is spreading elsewhere in Oz. Australian banks have recently been forced to raise interest rates in order to cover rising costs. The largest increase came from Melbourne's ANZ Banking Group—one of Australia's four largest banks—which raised rates by 20 basis points, to 8.77%, in early January. The three other major banks have followed with smaller increases.

Some of the banks' troubles stem from combined investments of nearly $880 million in the distressed U.S. mortgage group CountryWide Financial (CFC). The Commonwealth Bank of Australia and the National Australia Bank had each provided Countrywide with $264 million, while Westpac provided $88 million. Overall, the banks have watched their share prices fall by more than 10% since December, amid concerns about the global credit crunch.