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Emerging Markets and Crisis Applications for Out-of-Court Workouts: Lessons from East Asia, 1998-2001
William MakoWorld Bank23 March 2004
Introduction
Why out-of-court workouts?Different origins of crisesFocus on East Asia case, 1998-2001Importance of corporate-financial sector linkages
Agenda
I. Corporate-financial sector linkagesII. East Asia approaches to out-of-court
workoutsIII. ResultsIV. Easy lessonsV. Difficult lessons (“deal breakers”)
Incentives for debtor cooperation Inducement of financial sector losses Resolution of inter-creditor differences
Corporate cash flows determine sustainable level of corporate debt.
EBITDA: $100
Debt: $1000
$625 sustainable
$375 unsustainable
Assets: $1250
Equity: $250
Assumptions:•Need for 2:1 interest cover•8% market interest rate
Company X
Need to emphasize operational restructuring; Not just financial restructuring
Operational & ”Self Help”
Exit bad business Sales of non-core
assets Layoffs Other cost cuts New equity
Increase earnings/cash Reduce debt
Financial restructuring
Term extensions Rate reductions Grace periods Debt > convertible
bonds Debt > equity
Address moral hazard Avoid cosmetic fixes
Operational & financial restructuring may follow an iterative process
Stabilization, e.g. standstill
Debt rescheduling;Debt/equity swap
Creditor sakes ofConverted equity
Easy asset sales & cost cuts
Sales of major Assets/business
Financial
Operational
Losses from corporate restructuring may erode financial institution capital
Initial costs Present value costs of debt restructuring Temptation to avoid ( e.g, big “balloon”
payment)
Follow-on costs Asset sale prices may reveal over-valuation of
collateral Sale prices for converted equity may exceed
carrying value & crystallize a loss Temptation to neglect follow-on restructuring
Costs from general provisions
Corporate cash flows determine both sustainable corporate debt and costs of re-capitalizing weak financial institutions
Bank Y
Loans 1,000 150 850
Deposits 920
Capital 80 150<70>
Previous assumptions:•$1000 corporate credit•$375 non-sustainableNew assumption:•Bank loses 40% on Restructuring non-sustainable credit
All parties will naturally seek to minimize their own losses
Corporate debtors Outside
interference Sale of favored
assets Loss of business
line(s) Equity dilution Loss of control
Financial Institutions Capital write-
downs Equity dilution Nationalization Forced M&A Liquidation Loss of control
Government Goals
Minimize costs of bank re-capitalizationProtect workers/suppliersMinimize “ripple effects” Minimize distortions to market competitionAvoid labor strifeDampen public criticism enough to stay in office
Suggested Goals: ToPreserve/Promote Healthy Companies
Short-term (e.g., 3 months) Achieve financial stabilization Avoid liquidation of viable companies
Medium-term (e.g., 6-24 months) Operational restructuring Enhance profitability, liquidity, and solvency
Long-term Deter imprudent corporate over-investment
South Korea:Corporate Restructuring Accord
1998 “contract” among 210 domestic lenders 1-3 months standstill; extendable by 1 month Creditors Committee; usually led by Lead Bank 75% threshold for creditor approval Coordination Committee to arbitrate & give
guidelines Possible fines
Other key factorsLed to Corporate Restructuring Promotion Law (2001)
Malaysia:Corporate Debt Restructuring Committee
Under central bank auspicesEither debtor or creditor could initiateMinimum size: RM100 million debt; 5+ creditorsStandstill; creditors committee; etc.High threshold (100%) for CDRC creditor approval; lower thresholds for non-CDRC casesOther key factors
Thailand:Bangkok Rules + CDRAC
Initially, “Bangkok Rules” provided guidelinesReplaced by Debtor-Creditor Agreements 6-8 months schedule to develop/approve workout
plan Standstill, creditors committee, etc. 75% creditor approval to ratify plan 50-75% approval >>> amend and re-submit
3-person panel arbitrated inter-creditor differences Easy escape clause
Other key factors
Indonesia:Jakarta Initiative Task Force
Initial emphasis on consensual proceedings JITF to advise, mediate, facilitate & address
obstacles
JITF upgraded in April 2002 Could impose time-bound mediation Could orchestrate regulatory relief Could refer uncooperative debtor to Attorney
General for bankruptcy petition
Other key factors
East Asia Out-of-Court Workouts:Caseloads & Results
Korea Malaysia Thailand Indonesia
Total debt $88.9 bn
$10.4 bn $65.5 bn $18.9 bn
# of cases 83 54 14,917 n.a.
Complete cases
68 46 6,345 n.a.
Resolved debt
95% 77% 48% 56%
Financial:Ops Ratio
5:1 40:1 n.a. 13:1
New Money $3.7 bn n.a. n.a. n.a.
Accomplishments vs. Suggested Goals:Short-Term Financial Stabilization
Many SMEs failed – e.g., 19,000 in Korea 1997/8But not an immediate issue for large corporationsUnlikely that any good corporate failed due to liquidity crunchMore of a credit culture issue: Formal standstill; due diligence; creditor
monitoring (e.g., Korea) versus “Do-it-yourself” standstill; “strategic defaulting;”
no creditor oversight (e.g., Thailand, Indonesia)
Medium-Term Operational RestructuringKorea
More operational restructuring and “self help”But Korea still a mixed pictureThrough 2001, bottom quartile of corporates High debt, increasing losses, more negative cash
flow
Success stories like Daewoo: Workforce reductions of 25-60% Strategic sales and spin-offs, e.g., Motors to GM E&C, Heavy, & Shipbuilding – good profitability,
leverage, and interest cover by 2001
Medium-Term Operational RestructuringOther Countries
Financial restructuring dominated, e.g., Indonesia JITF: 93% of debt rescheduled or
converted Malaysia CDRC: almost no asset sales; zero
coupon bonds
Frequent “balloon payment” arrangementsRelapse risk for operationally flabby companiesCorporate debt recidivism an issue in 2001
Long-Term Deterrence of Debt-Fueled Corporate Over-Investment
Korea – no chaebol “too big to fail” 25 (with $33B debt) into receivership since 1996 Wipeout of Daewoo’s controlling shareholders Creditor control at Hyundai MH Group companies Encouraged cooperation with out-of-court workouts
Thailand & Indonesia No near threat of foreclosure, liquidation,
receivership Un-cooperative debtors may hang on; albeit with
questionable future access to debt financing
Easy Lesson #1:Principles and Processes
Several good examples from East Asia “Bangkok Rules” perfectly fine; just not
enforceable Malaysia CDRC’s August 2001 rules on
workouts Korea: Model commitments by
debtors/creditors
Available; readily replicable
Easy Lesson #2: Need to Address Legal/Regulatory Issues, e.g.
Tax issues (e.g., corporate income, M&A, NOLs)Review period for M&APersonal liability for employees of State banksLimits on bank holdings of corporate equityLegal lending limitsPossible de-listing by local stock exchangesPublic tender requirement in debt/equity swapPublic shareholder resistance to equity dilution
Easy Lesson #3:Need to Address Capacity Constraints
Huge demands: insolvency judges, admin- istrators, professionals, government crisis teamSegmentation of the problem, e.g., Malaysia: Big cases >> courts or out-of-court workout Medium cases >> asset management company
(AMC) Small cases >> bank workout departments
AMC focus on bulk sales of un-restructured NPLsRestructuring joint ventures (e.g, Korea’s KAMCO, CRCs)
Deal-Breaker #1:Incentives for Debtor Cooperation
Serious restructuring usually causes some loss to corporate shareholders/managementAbility to impose losses; encourage cooperation Korea vs. Thailand/Indonesia
Useful “sticks” Creditor access to foreclosure, liquidation,
receivership Simple commencement criteria (performance-
based) Easy conversion to receivership/liquidation
Deal-Breaker #2:Inducement of Financial Sector Losses
Banks may support superficial restructuring >> “zombie” companiesBest response: forced sale of “excess” NPLsAlternative: forbearance should be approached cautiously Banks may use as opportunity to “double their bets” Forbearance on loss recognition may encourage
assets overvaluation; discourage follow-on restructuring
May also impede bank recapitalization (due diligence)
Any forbearance should be strictly limited in scope/duration
Deal-Breaker #3: ResolvingInter-Creditor Differences Out-of-Court
Often stickier than debtor/creditor differencesEx post facto imposition of arbitration could be challengedFinancial supervisor enforcement poses conflictsOther alternatives:
Law (e.g., Korea, 2001) to force sales by holdout creditors, at an independent valuation
Rely on lower thresholds for reorganization in court Facilitate majority creditor recourse (“pre-packaged”
bankruptcy) to ratify/enforce workout agreement
Main Lessons
1. For debtor cooperation, no serious alternative to credible threat of total loss, e.g., from foreclosure, liquidation, or receivership
2. For adequate support from financial institutions, readiness by supervisor to force/induce loss recognition
3. For inter-creditor differences, a reliable & non-problematic resolution mechanism (e.g., “pre-packaged” bankruptcy)
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