Turning the tide

The Australian dollar’s rally since the turn of the year has prompted speculation that some of the country’s exporters may begin to unwind hedge positions that last year left them with vast mark-to-market losses, say bankers.

The steady rise of the Australian dollar to a high of $0.575 so far this year has made the millions of dollars in mark-to-market losses on the balance sheets of some of the country’s export-reliant companies more manageable, and could be the impetus firms have been waiting for to unwind their positions, say some bankers. “Potentially, the Australian dollar is probably going to be capped on any significant rise, with people taking the opportunity to unwind deeply out-of-the-money books,” comments Ian Collins, director of credit and rate markets at JP Morgan in Sydney. “There will be a tendency to close [out residual hedging books] for maybe a A$100 million mark-to-market loss compared with where they were with much higher losses.”

Last year’s slump of the Australian currency, which reached a record low of $0.4775 in April 2001, decimated the balance sheets of many of the country’s export-focused resource companies. The currency fell from $0.80 in 1997 to around $0.60-0.65 in 2000 before tumbling further last year. However, many resource companies had locked in at the $0.60–0.65 level in 2000, as much as five years forward, meaning they were unable to benefit from the currency’s depreciation.

Consequently, a spate of resource companies reported hefty mark-to-market hedging losses in last year’s annual reports, much to the fury of shareholders and press alike. For example, mining and mineral processing company MIM Holdings reported forex hedging losses of A$110.8 million ($60.57 million) from the six-months to December 2001, and

Western Mining Corporation registered losses of A$198.1 million ($108.3 million) from currency hedges in the last six-months of 2001. Meanwhile, Melbourne-based resource company Pasminco’s foray into currency hedging, buying call options at $0.68 and selling put options at $0.65 to protect it against a rise in the currency that never materialised while at the same time leavings its commodity exposure unhedged, directly contributed to its collapse last year.

Even the Australian government has not escaped, coming under heavy fire from opposition political parties for racking up around A$4.85 billion ($2.65 billion) in mark-to-market losses from Australian dollar/US dollar cross-currency swaps. The Australian Office of Financial Management, the government department that manages the country’s debt, has since stated it will undertake a phased rundown of existing exposures using forward contracts over a period of up to eight years.

But while bankers agree some companies are considering a possible unwinding of positions as the currency shuffles upwards, this strategy has yet to emerge. “It’s a consistently talked about thing,” says Mark Carrodus, director and head of foreign exchange trading at Deutsche Bank, in Sydney. “Evidence would suggest that the appreciation of the Australian dollar hasn’t been significant yet for that dynamic to play out.”

Adds JP Morgan’s Collins: “It hasn’t happened yet, but I know that people are starting to think about it. I think they are looking for [the Australian dollar] to go a little bit higher before that happens.”

Any restructuring that does occur will likely be a gradual process using primarily plain vanilla products. “The general play is to try and work their way slowly out of their existing hedge positions and when they do restructure, do it in smaller pieces,” says Malcolm Thompson, Sydney-based director of foreign exchange distribution at SG Australia, part of French bank Société Générale. “It will probably be in simpler products as well, rather than getting involved with the structures that got them into the bad positions in the first place.”

But while some of the larger players have been looking to unwind hedging positions, some of the smaller exporting firms have been entering into forex hedges to take advantage of the currency’s rise, says Simon Wright, executive director, foreign exchange division, at Macquarie Bank in Sydney. “Some of the small players are using it as an opportunity to try and improve their internal rate of return on their export sales,” he says. And some are hedging out to two years forward in anticipation of the currency rising further, in some cases using more structured products such as barrier options. “We’ve had a few of these companies hedge at the low $0.50s and they’ve done quite well,” he adds.

SG’s Thompson agrees that some of the second-tier resource companies have been among the most active participants in the forex market this year as the forward curve sits in their favour. “You can’t find a bank that has a forecast on the Australian dollar at less than $0.60 out 12 to 18 months,” he says. But overall, the larger resource companies have been absent from the forex derivatives market, with firms either waiting for the existing, out-of-the-money positions to roll off or switching to US dollar balance sheets. A flurry of acquisitions and consolidation in the resource sector over the past few years – Rio Tinto and BHP Billiton for instance – has meant that more companies are switching to US dollar balance sheets, leaving them with little need to hedge US dollar revenue from exports. “There’s very few independent mining companies left in Australia, and most of the global mining companies see themselves as US dollar houses anyway,” says JP Morgan’s Collins. “So they only hedge their Australian dollar cost base, as opposed to revenues.”

Yet even while current exchange rates favour exporters that want to lock in future revenues, those remaining large domestic corporates with Australian dollar balance sheets face resistance from shareholders and analysts to put on new hedges, says Thompson. “The forward curve is at a level where they should be putting more cover on but they are hamstrung because they already have this three to five year cover that is out-of-the-money that stops them putting additional cover on,” he notes. SF, NS