RBA sounds default warning for mining service companies

The Reserve Bank of Australia says mining service companies are facing the risk of default in light of falling commodity prices.

The warning comes in RBA’s Financial Stability Report which states the prices of oil and iron ore had fallen more sharply than expected, following earlier large declines in coal prices.

The RBA says these lower commodity prices have reduced the profitability and cash flow of Australian resource producers, which have responded by reducing planned capital and targeting greater efficiencies.

“The prospects for mining services companies have therefore also weakened, compounding the already subdued conditions in this sector as the investment phase of the mining boom winds down,” the bank said in its report.

The profits of listed mining service companies have fallen by more than 15 per cent as a result.

The bank said while the full effects of the falls in commodity prices are yet to be felt, these headwinds could make it more difficult for resource-related firms to service their debt, raising the risk of default.

The report noted that the credit ratings of some resource-related companies have already been downgraded, while ratings implied by credit default swaps and bonds suggest that the market expects more downgrades to follow.

But the bank was quick to point out that even if this did happen, the risk to financial stability in Australia would be limited.

RBA staff estimate that the combined value of exposures of the Australian banking system to resource producers and services companies is only around 2 per cent of banks’ total exposures.

While mining services firms account for only 16 per cent of debt owed by listed resource-related corporations.

It also said the finances of listed resource-related corporations are generally quite robust.

“In aggregate, the gearing and debt-servicing ratios for resource producers remain noticeably lower than those of the broader listed corporate sector.”

In addition, most of the debt is owed by large companies that have neither high gearing nor high debt-servicing ratios; these companies are generally expected to be relatively well placed to ride out a period of low commodity prices because they have reasonably strong balance sheets, low costs of production, high margins and access to other sources of funding.

“Nonetheless, several smaller resource producers (including in the coal and iron ore industries) are likely to struggle to cover costs at current prices,” RBA warned.

It said parts of the mining services sector will find the current operating environment challenging, particularly those firms that are more exposed to resource investment or exploration.

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