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William Mako World Bank 23 March 2004

Emerging Markets and Crisis Applications for Out-of-Court Workouts: Lessons from East Asia, 1998-2001. William Mako World Bank 23 March 2004. Introduction. Why out-of-court workouts? Different origins of crises Focus on East Asia case, 1998-2001

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William Mako World Bank 23 March 2004

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  1. Emerging Markets and Crisis Applications for Out-of-Court Workouts: Lessons from East Asia, 1998-2001 William Mako World Bank 23 March 2004

  2. Introduction • Why out-of-court workouts? • Different origins of crises • Focus on East Asia case, 1998-2001 • Importance of corporate-financial sector linkages

  3. Agenda • Corporate-financial sector linkages • East Asia approaches to out-of-court workouts • Results • Easy lessons • Difficult lessons (“deal breakers”) • Incentives for debtor cooperation • Inducement of financial sector losses • Resolution of inter-creditor differences

  4. Corporate cash flows determine sustainable level of corporate debt. Company X Assets: $1250 Debt: $1000 $625 sustainable Equity: $250 $375 unsustainable EBITDA: $100 • Assumptions: • Need for 2:1 interest cover • 8% market interest rate

  5. 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 Need to emphasize operational restructuring; Not just financial restructuring

  6. Operational & financial restructuring may follow an iterative process Financial Operational Stabilization, e.g. standstill Easy asset sales & cost cuts Debt rescheduling; Debt/equity swap Sales of major Assets/business Creditor sakes of Converted equity

  7. 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

  8. Corporate cash flows determine both sustainable corporate debt and costs of re-capitalizing weak financial institutions Bank Y 1,000 150 850 920 Loans Deposits 80 150 <70> Capital • Previous assumptions: • $1000 corporate credit • $375 non-sustainable • New assumption: • Bank loses 40% on Restructuring non-sustainable credit

  9. 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 All parties will naturally seek to minimize their own losses

  10. Government Goals • Minimize costs of bank re-capitalization • Protect workers/suppliers • Minimize “ripple effects” • Minimize distortions to market competition • Avoid labor strife • Dampen public criticism enough to stay in office

  11. 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

  12. 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 factors • Led to Corporate Restructuring Promotion Law (2001)

  13. Malaysia:Corporate Debt Restructuring Committee • Under central bank auspices • Either debtor or creditor could initiate • Minimum size: RM100 million debt; 5+ creditors • Standstill; creditors committee; etc. • High threshold (100%) for CDRC creditor approval; lower thresholds for non-CDRC cases • Other key factors

  14. Thailand:Bangkok Rules + CDRAC • Initially, “Bangkok Rules” provided guidelines • Replaced 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

  15. 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

  16. East Asia Out-of-Court Workouts:Caseloads & Results

  17. Accomplishments vs. Suggested Goals:Short-Term Financial Stabilization • Many SMEs failed – e.g., 19,000 in Korea 1997/8 • But not an immediate issue for large corporations • Unlikely that any good corporate failed due to liquidity crunch • More 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)

  18. Medium-Term Operational RestructuringKorea • More operational restructuring and “self help” • But Korea still a mixed picture • Through 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

  19. 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” arrangements • Relapse risk for operationally flabby companies • Corporate debt recidivism an issue in 2001

  20. 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

  21. 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

  22. Easy Lesson #2: Need to Address Legal/Regulatory Issues, e.g. • Tax issues (e.g., corporate income, M&A, NOLs) • Review period for M&A • Personal liability for employees of State banks • Limits on bank holdings of corporate equity • Legal lending limits • Possible de-listing by local stock exchanges • Public tender requirement in debt/equity swap • Public shareholder resistance to equity dilution

  23. Easy Lesson #3:Need to Address Capacity Constraints • Huge demands: insolvency judges, admin- istrators, professionals, government crisis team • Segmentation 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 NPLs • Restructuring joint ventures • (e.g, Korea’s KAMCO, CRCs)

  24. Deal-Breaker #1:Incentives for Debtor Cooperation • Serious restructuring usually causes some loss to corporate shareholders/management • Ability 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

  25. Deal-Breaker #2:Inducement of Financial Sector Losses • Banks may support superficial restructuring >> “zombie” companies • Best response: forced sale of “excess” NPLs • Alternative: 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

  26. Deal-Breaker #3: ResolvingInter-Creditor Differences Out-of-Court • Often stickier than debtor/creditor differences • Ex post facto imposition of arbitration could be challenged • Financial supervisor enforcement poses conflicts • Other 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

  27. Main Lessons • For debtor cooperation, no serious alternative to credible threat of total loss, e.g., from foreclosure, liquidation, or receivership • For adequate support from financial institutions, readiness by supervisor to force/induce loss recognition • For inter-creditor differences, a reliable & non-problematic resolution mechanism (e.g., “pre-packaged” bankruptcy)

  28. Outstanding Issues • Enhanced monitoring of corporates • Financial stabilization for SME suppliers • Role of forbearance & adequate controls • Relative performance of public, private, and public-private restructuring/resolution efforts

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