Aussie banks at risk of bad-debt blowout as steelmaker collapses

People outside the Commonwealth Bank headquarters in Sydney on Feb 10.
People outside the Commonwealth Bank headquarters in Sydney on Feb 10.PHOTO: AFP

SYDNEY (BLOOMBERG) - Commonwealth Bank of Australia and its competitors are staring at a potential blowout in bad-debt expenses as they try to claw back a combined A$1 billion ($753 million) of loans to steel and iron ore supplier Arrium Ltd, underscoring the looming threat to lenders from the commodities bust.

The banks may recoup less than 50 cents on the dollar they lent to the Sydney-based company, which handed control to an administrator on Thursday (April 7) after lenders rejected its US$927 million recapitalization plan with Blackstone Group's GSO Capital Partners.

The turn in the commodities cycle is impacting companies from miners to oil explorers and causing trepidation for banks that have lent them billions of dollars across the world. Bad-debt provisions at Australia's largest lenders are set to rise to their highest in eight years by 2018, as the chances of defaults in the mining, agricultural and dairy sectors increase, according to a survey by Bloomberg last month.

"It's a negative for the four big banks given they are unsecured creditors," said Omkar Joshi, a Sydney-based investment analyst at Watermark Funds Management, which manages A$1 billion. "It is also negative because it looks like the banks wouldn't even get the 50-55 cents on the dollar that was expected under the GSO proposal."

Commonwealth Bank, Westpac Banking and National Australia Bank each had lent A$250 million to Arrium, according to people familiar with their exposure to the stricken steelmaker. Australia & New Zealand Banking Group, which is Arrium's transaction bank, has a facility of more than A$200 million, one of the people said.

Spokesmen at the four lenders declined to comment.

As late as Wednesday, the four largest lenders offered to provide as much as A$400 million in additional loans to maintain cash flow and keep the company's steel mill running, provided Arrium appointed an administrator of their choice, two people familiar with the discussions said. The banks were concerned that a possible closure of the mill in Whyalla, a town in South Australia state largely dependent on the steelworks, would hurt the local economy through hundreds of job cuts and in turn lead to defaults on loans to consumers, the people said.

"The lesson here is, if you are in a cyclical commodity business and you grow using bank debt, you are going to come unstuck when the cycle changes," said Matthew Hodge, an analyst at Morningstar Inc. in Sydney. "They had no competitive advantage whatsoever with their iron-ore operations. If they had raised equity and paid down some of that debt, we wouldn't be having this conversation."

Arrium's net debt expanded to A$2.1 billion as of Dec 31 from A$1.75 billion six months earlier. It said Thursday that talks with lenders "have now ceased."

Global steel mills are struggling to contend with steel exports from the largest producer, China, which last year boosted its export of the metal to an all-time high.

Arrium flagged in February it may mothball its loss-making Whyalla plant and last year shuttered iron-ore mines and booked writedowns. Its underlying net loss in the six months to Dec 31 widened to A$24 million from A$22 million a year earlier. The company had been in talks with its lenders for months and in February announced a potential recapitalization plan with GSO Capital.

The four largest Australian banks have a combined A$65.6 billion in loans to the resources sector, about 1.8 per cent of their total A$3.56 trillion in assets, based on their latest filings. ANZ's mining exposure stood at 2.2 per cent of its total loans, while the measure was at 1.5 per cent for Westpac, 1.8 per cent for Commonwealth Bank and 1 per cent for National Australia, according to their latest filings.

ANZ warned of a A$100 million blowout in bad debt charges March 24 and Westpac's chief financial officer Peter King the same day said the lender may need to raise provisions for five institutional clients.