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Fortescue Rallies From Rout as Breach Averted: Australia Credit

September 18, 2012

Fortescue Metals Group Ltd. (FMG) bonds, the worst performers in dollar-denominated junk markets this quarter, are rallying after the Australian iron ore miner got $4.5 billion of loans to avoid breaching terms on existing debt.

The nation’s third-biggest producer of the steel-making ingredient will use funding from Credit Suisse Group AG and JPMorgan Chase & Co. to replace current bank facilities, Perth- based Fortescue said yesterday. The five-year secured loan removes all covenants and pushes out the first repayment until November 2015, Chief Executive Officer Nev Power said yesterday in an interview on Bloomberg Television.

“This is a good outcome for both equity and credit holders and is clearly preferable to risking a covenant breach and the potential loss of liquidity,” said Michael Bush, Melbourne- based head of credit research at National Australia Bank Ltd. “It certainly places Fortescue in a far better position than where it was a week ago.”

Investor concern that Australia’s resources-driven economy may slow mounted after iron ore dropped to the lowest since October 2009 this month, spurring Fortescue to cut spending plans by 26 percent and hold talks with lenders about potential covenant waivers. Yield premiums on the miner’s bonds surged 104 basis points this quarter to 658 on Sept. 17, the biggest increase among the top 50 issuers in Bank of America Merrill Lynch’s High Yield Master II Index. Spreads on the overall gauge narrowed 112 basis points to 532.

Junk Bonds

Fortescue has sold $7.04 billion of junk bonds in the U.S. in the past two years, making it the 8th biggest issuer of such securities during the period, according to data compiled by Bloomberg. Non-investment grade bonds, also known as high-yield or junk, are rated below BBB- by Standard & Poor’s and Fitch Ratings, and lower than Baa3 by Moody’s Investors Service.

The extra yield investors demand to hold Fortescue’s $2.04 billion of 7 percent November 2015 bonds instead of Treasuries dropped 62 basis points to 647 at 6 p.m. in Sydney yesterday, the least since Aug. 29, according to BNP Paribas SA. The spread has widened 28 basis points this quarter, the prices show.

Shares in the company, rated Ba3 by Moody’s and BB- by S&P, surged 17 percent yesterday to A$3.50, the biggest gain since June 2009.

Iron ore, Australia’s biggest export earner, rebounded 21 percent to $105.10 a metric ton on Sept. 17 from the near-three- year low touched on Sept. 5. The commodity has averaged $132.215 a ton this year, according to an index of prices at Tianjin port from the Steel Index.

Deferred Development

Fortescue deferred the development of its Kings deposit and completion of the fourth berth at its Herb Elliott Port this month as part of plans to reduce spending to $4.6 billion in the year ending June 30, 2013. The company has received “strong interest” from parties interested in partnering with Fortescue and is evaluating those approaches, it said yesterday in a statement.

“We’re fairly comfortable, with even depressed iron ore prices, that the company can generate good cash flow,” Brian Nold, senior high-yield portfolio manager at Seix Investment Advisors LLC, which oversees about $26 billion and owns Fortescue bonds, said in a telephone interview. “With that risk profile potentially diminishing, in terms of lowering capex and iron ore pricing improving, it helps create some kind of floor” on bond prices.

Fortescue will have access to an extra $900 million in cash from the new loan once it has refinanced existing facilities, CEO Power said on a conference call yesterday.

Ride Out Volatility

“This package effectively removes all of the restrictions and all of the time pressure out of our balance sheet to allow us the time and flexibility to finish our expansion and to ride out any volatility in our ore prices,” Power told Bloomberg Television yesterday.

The loan is “a pretty positive resolution of the covenant issues,” said Mark Bayley, a Sydney-based credit strategist with advisory company Aquasia Ltd. “This is a better solution than the banks taking immediate control of the company.”

Australia, the world’s largest shipper of iron ore and coal, yesterday cut its forecast for earnings from minerals and energy resources exports on lower commodity prices.

The value of exports may total A$189.2 billion ($197.2 billion) in the year started July 1, the Bureau of Resources and Energy Economics said in a report. That compares with a June estimate of a record A$209.5 billion. Iron ore prices will average $126 a ton in 2012, down from a June estimate of $136, the government research unit said.

Rate Cut

Australia & New Zealand Banking Group Ltd. expects the Reserve Bank to reduce its key interest rate in back-to-back cuts in the next two months, taking the benchmark to 3 percent from 3.5 percent as lower resources prices and a strong currency curtail growth, the bank said in an e-mailed statement yesterday. It had previously forecast a 25 basis-point reduction in November, then another in the first quarter of 2013.

The so-called Aussie, the world’s fifth-most traded currency, bought $1.0427 as of 6 p.m. in Sydney yesterday. Benchmark 10-year government bond yields dropped 10 basis points to 3.33 percent, or 151 basis points more than similar maturity Treasuries.

The Markit iTraxx Australia index of credit-default swaps that gauges corporate bond risk rose five basis points to 140 yesterday, according to Markit Group Ltd.

Contracts on Rio Tinto Group and BHP Billiton Ltd. (BHP), the two largest exporters of iron ore from Australia, have fallen this month, showing improved perceptions of creditworthiness. Fortescue doesn’t have widely-traded default swaps on its debt.

Mine Delay

BHP, the world’s biggest mining company, last month decided to delay approval of an estimated $33 billion expansion of the Olympic Dam copper, uranium and gold mine in South Australia. It also postponed investment decisions on an iron ore port expansion in Western Australia and a potash development in Canada.

Rio Tinto, the third-largest miner, plans to cut some jobs at the Argyle diamond mine in Western Australia to reduce costs and improve efficiency amid a plan to sell its diamond businesses. Rio in October last year said it intended to sell 13 aluminum assets, including smelters and alumina plants in Australia, the U.S. and U.K., to improve its finances.

“Fortescue’s future from here is contingent on the iron ore price,” Peter Rudd, resources and mining manager at Altitude Private Wealth in Melbourne, said by telephone. “The boom in terms of output isn’t over but in terms of maximum revenue given lower commodity prices, it’s in the past.”

To contact the reporter on this story: Sarah McDonald in Sydney at

To contact the editor responsible for this story: Shelley Smith at

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