Commodities

David Fickling is a Bloomberg Gadfly columnist covering commodities, as well as industrial and consumer companies. He has been a reporter for Bloomberg News, Dow Jones, the Wall Street Journal, the Financial Times and the Guardian.

Remember that Bugs Bunny scene where the Tasmanian Devil survives an explosion by eating the bomb? China's government is trying to do that for its indebted miners.

Rather than let the domestic mining industry be dragged down by its $131 billion of debts, the authorities are looking at setting up what amounts to a state-owned "bad bank" to segregate the worst liabilities and allow the remaining businesses to survive, people with knowledge of the matter told Bloomberg News.

China Minmetals, the metals trader and miner tasked with swallowing up China Metallurgical Group in a state-brokered merger, will be one taker, these people said. That should help with its net debt, which already stood at 136 billion yuan ($22 billion) in December 2014.

There'll be no shortage of others lining up for relief. Seven of the 17 most debt-laden mining and metals companies worldwide are in China, and all are state-owned or -controlled, according to data compiled by Bloomberg:

Going for Broke
Seven of the 17 most indebted mining and metals companies are Chinese
Source: Bloomberg data
Note: Shows all mining, aluminum and non-ferrous metals companies with net debt above $2 billion and net debt/Ebitda above 4

Western credit investors have become so chary of miners' debts that you can pick up bonds with a 100 percent annual yield if you're confident the companies will last the year, according to Gadfly columnist Lisa Abramowicz. Anglo American is firing 63 percent of its workforce and selling at least half its mines to cut debt, while Glencore today announced plans to further decrease its borrowings. The political strategist James Carville once joked that he'd like to be reincarnated as the bond market so he could "intimidate everybody."

In China, things are considerably more relaxed. Chalco, one of the top five global aluminum producers, hasn't generated enough operating income to pay its interest bills in any half-year since 2011, according to data compiled by Bloomberg. Over the four-year period, interest payments have exceeded earnings by about 29 billion yuan, the data show:

Foiled
Chalco's operating income last exceeded its interest payments four years ago
Source: Bloomberg data

It's a similar picture in China's coal industry. China Coal Energy, Yanzhou Coal, and Shaanxi Coal, the second-, fourth-, and fifth-biggest domestic producers by sales, have collectively spent 3.3 billion yuan more on interest over the last 12 months than they've earned from their operations.

This situation can't go on. While Chalco still has about 47 billion yuan in shareholders' equity on its balance sheet, it doesn't have an obvious path back to profitability and most of its excess interest payments were made before aluminum prices started to really slump, back in May. There are also some worrying dates looming: The company has 13.6 billion yuan in bonds maturing next year, and another 20.9 billion yuan in the two years following, according to data compiled by Bloomberg.

Bad banks have some benefits. By transferring debts to the parties most able to pay them -- in this case, the Chinese government -- they enable companies to survive without mass layoffs and the disruptions of bankruptcy. But they're no panacea.

While Citi Holdings, the Citigroup unit set up to segregate its bad assets during the 2009 financial crisis, has finally started turning a profit, the bank as a whole has yet to return to the $5 billion-a-quarter net income performance it routinely put in before the downturn hit, and it continues to be priced at a discount to book value.

Not Too Bad
Citigroup's bad bank, Citi Holdings, is producing net income at last
Source: Bloomberg data

Cutting the debts of China's miners will produce a similar outcome. The short-term problem will be solved, but the long-term issues facing the industry aren't going away. Indeed, by keeping its mining companies in business longer than they'd survive in the wild and preventing bankruptcy from doing its job of shutting down the metals production China doesn't need, Beijing's bad bank will only prolong the pain afflicting the industry worldwide.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
David Fickling in Sydney at dfickling@bloomberg.net

To contact the editor responsible for this story:
Paul Sillitoe at psillitoe@bloomberg.net