The Oz Minerals cash crisis represents another delicate moment for the Australian banking system. The banks narrowly averted a catastrophe in the property sector by keeping Centro technically alive. Now they face a similar challenge in the resources sector.
The speed and severity of the collapse in base metals prices has been shocking. As Oz Minerals’ Andrew Michelmore told Business Spectator, in three months the fall in prices has, if it is sustained, wiped $1.4 billion from next year’s revenues.
It may yet, of course, get worse. Goldman Sachs’ analysts recently looked at the impact of commodity prices retreating to pre-boom (2002) levels. In that scenario only BHP Billiton would be profitable, partly because of the escalation of costs in the sector during the boom years.
But the analysts also said they believed there wouldn’t be a return to pre-boom prices, partly because the structural cost of producing commodities has risen and partly because there has already been a substantial supply-side response, with already-announced cuts to global production in 2009 of about 16% of the firm’s original forecasts.
There is little doubt, however, that 2009 will be a very tough year for the resources sector and that there will be a significant number of casualties if the banks adopt a hardline approach predicated on the current conditions continuing indefinitely.
Oz Minerals is an unusual case. It is, as Michelmore has said, asset rich and cash poor and was made vulnerable largely because it was trying to organise a restructuring of $1 billion of borrowings at the wrong moment. Whether its assets are worth $7 billion, as some analysts have calculated, or $2 billion, there is a very large buffer between its bankers and their first $1 of losses.
The fact that they are unlikely to lose a cent on their exposure – the sale of Oz Minerals’ Prominent Hill project by itself would repay their loans – appears to have encouraged some banks to be quite gung ho in pushing the group towards the precipice.
There are, however, broader considerations. If Oz Minerals is given the time to organise an orderly sale of either an interest in Prominent Hill or one or more of its other projects all that will happen is the sale of those interests and the repayment of some or all of the debt. If the banks were to put the group under, the entire Oz Minerals portfolio would be dumped into the market.
Oz Minerals isn’t quite a Centro, one of the largest retail property centre owners and managers in the world. Had Centro formally failed its property portfolios would have over-hung the Australian and US markets and would have had a massively negative impact on property values generally.
ANZ’s chief executive, Mike Smith, in an interview with The Australian at the weekend, referred to Centro as an emblematic exposure for the Australian banks, one that had to be supported because the alternative was unpalatable.
“There is no point in pulling the plug, because what happens then? The whole bloody thing spirals down. All the banks would have to re-evaluate the credit risk on their portfolios. That would require increasing capital and it goes on and on. You have got to be calm, considered and sensible. This is a time for statesmanlike banking.”
Smith and ANZ’s chairman-elect, Rod Eddington, are said to have been active in persuading other banks in the Centro syndicate not to pull the plug on the group and in the process pull the rug from under the property sector.
Centro, thanks to a massive debt-for-equity swap, is technically still alive and its portfolio, rather than being dumped into an highly illiquid market, is intact.
As we tick into 2009 and the stresses on the resource sector intensify, the banks will face an analogous challenge in trying to determine which companies and projects could have systemic implications if they fail.
There will be plenty of late entrants to the commodity boom with high costs and low grades that will be unviable in anything but those aberrational conditions. Equally there will be others that, if they are supported through the next year or so will survive and perhaps even prosper as marginal production is forced from the market and the supply-demand equation continues to tighten.
If the banks act unintelligently and take advantage of the opportunities to act whenever a refinancing event arises, they will cut a swathe through the resources sector that will undermine valuations and have the kind of circular and destructive effect on their own balance sheets and capital requirements that Mike Smith feared. It is in their own interests to be, well, statesmanlike.