Sunday, March 22, 2015

Asia’s recurring debt angst: deja vu all over again


 “You do know that ‘Kaisa’ means “How” in Hindi”, quipped an Indian friend who is a fund manager in Asia. Well, there’s certainly been no shortage of ‘How’ questions on Kaisa (1638.HK), the first Chinese property company to default on its offshore U.S.-denominated public bond obligations in the history of the Asian high yield market. When the company went into a tailspin towards the end of 2014, a number of key questions popped up.

The most relevant were:

·         How would the local governments in China suddenly turn against Kaisa and disallow further sales of its various properties?

·         How were the local banks still lending to this company pretty much till the last day?

·         How did a bid from Sunac (1918.HK) – another Chinese real estate company – come about?

·         How did the controlling family sell out without any consequences?

·         How did a Hong Kong-listed public company under-report its debts?

·         How can a company that made a fair amount in the first half turn around and report a whole-year loss based on reversals of sales?

·         How do equity holders of Kaisa get priority over bond holders; as is being demanded by Sunac for taking over Kaisa?

There are other questions, in the “Why”, “When”, “Where”, “Who” and “What” camps as well, relating to Kaisa and what promises to be a fairly messy default in China. This article though, isn’t about Kaisa. It’s more about the trends of debt in Asia and that ever-familiar sense of deja vu one gets whenever the subject turns to lending in this region. Think of the following imponderables when we look for evidence that lending in Asia is somehow very different (and far more risky) than in developed parts of the world:

Case 1: Kingfisher Airlines, India (KAIR.IN)

1.      When Indian airline Kingfisher, collapsed in 2012; it was disclosed that state-owned banks had continued to lend to the company for over 5 years after it had stopped making profits and indeed wiped out its equity capital

2.      Even secured creditors of Kingfisher – aircraft leasing companies among them – found that they couldn’t repossess the aircraft operated by Kingfisher. In some cases, there was material damage to the aircraft – including missing parts – when repossession was finally achieved.

3.      Employees who had not been paid somehow got payment priority over secured creditors. But interestingly,  the tax authorities received a priority over both.

4.      India’s creaking legal system came into full view over the course of this bankruptcy, with a number of mind-bogglingly stupid decisions being made public over the time. A particularly galling example when the head of Kingfisher Airlines – a billionaire in his own right whose personal fortunes don’t seem to have suffered from the bankruptcy of Kingfisher Airlines – successfully got the courts to overturn a label of “willful defaulter” from a state-owned bank

Case 2: Bumi Resources, Indonesia (BUMI.IJ)

1.      Then you have the case of Bumi Resources, one of the world’s largest coal miners which hadalso been considered one of the top companies in Indonesia

2.      The company’s politically connected Bakrie family had a series of public spats with co-investors including Nat Rothschild over the London listed BUMI.LN which controlled nearly 30% of the Indonesian listed entity. This was followed by an acrimonious split that saw the Bakrie family repurchase the London company’s stake in the Indonesian asset for $500 miilion while selling its own stake in the London company to a fellow Indonesian tycoon (Samin Tan) for around $230 million.

·         Banks that lent money to both Bakrie Group and Samin Tan – rumoured to include some of the world’s biggest ones – are said to have absorbed horrific losses without any chance of recourse to the families’ massive assets elsewhere.

1.      Focusing so much on control issues seems to have cost Bumi Resources precious management time, leading to a default on some $4 billion of debt late last year. This default included obligations to CIC and China Development Bank; both very politically connected Chinese financial entities. Rumours have abounded of key decision makers in both companies losing their jobs due to the losses on the exposure to Bumi

2.      There is some $1billion of public bonds issued by Bumi on which a default persists; but strangely for such a major bond issue, there has not been any publicly announced restructuring. The bonds are secured with the same collateral that underpins the company’s USD loans and yet there is no semblance of a wider restructuring either.

The echoes of 1997 – nothing changes

Looking at these cases, its difficult to shake off a feeling that nothing changes in Asia until and unless it really has to under the force of circumstances. The following are the key pitfalls of lending to the region:

1.      There is no real bankruptcy framework that applies across the region. This is understandable given the different jurisdictions and local history. However, pretty much nothing excuses the lack of legal enforcement power in the region for creditors as a whole. This is especially true when one considers that  many of them – such as multinational banks and hedge funds – operate across the region rather than in specific countries.

2.      Offshore liabilities are treated as ‘second class citizens’ by Asian courts, by and large. This is both incorrect from a fairness point of view and illogical from a monetary benefit perspective.

3.      Even when it comes to domestic bankruptcies, countries like China, India and Indonesia have a long way to go before they can fully secure the rights of creditors and reduce the power of borrowers who tend to be large, politically connected families.

4.      Debt restructuring companies for banks in China, India and Indonesia have limited powers to deal with errant borrowers. While some laws such as SARFAESI in India have caused a paradigm shift in enforcement, these are only applicable in limited cases and for limited types of collateral.

5.      Courts across Asia appear particularly prone to inefficient outcomes – with various causes ranging from corruption and lethargy to plain old incompetence – being seen as the culprits by legal professionals across the region. Accepting the jurisdiction of foreign courts – particularly in the case of U.S.-denominated bonds – have remained problematic for the region due to illusions of independence and sovereignty (it remains my opinion that sovereignty issues are largely self-serving nonsense peddled by errant borrowers who happen to be politically connected across these countries)

So who cares if this isn’t fixed

Reading all of the above, a reader can’t be faulted for asking an obvious question – if nothing has changed, what’s the point of changing it? The answer to that is worthy of a separate article. But a summary of my views are appended below:

1.      Lending institutions tend to be state-owned and if not, at least deposits are state-guaranteed across Asia. Thus any losses from busted loans directly affects savers across the region, if not the governments that guarantee them.

2.      As the recent Chinese crackdown on corruption showed, avenues for mal-investments can be multiplied if borrowers can do so without fear of consequences. Overbuilding capacity and corruption / money laundering are just two sides of the same coin.

3.      Resolution of bankruptcies provides opportunities for new businessmen or in some cases, new classes of entrepreneurs. The general refrain of a select group of families controlling Asian economies – China, India and Indonesia all suffer from this, as do Korea and Japan – stems from the ability of established companies to remain in business far longer than they should on a pure economic basis.

4.      More to the point, “old cronies” i.e. capitalists who gained from past governments, have tended to remain powerful due to the inefficient process of bankruptcy across the region. This helps to reverse many of the socio-political gains that the region’s people have fought long and hard for; Indonesia’s democracy is a classic case in point where a popular people’s movement that pushed current President Jokowi into power has to confront the might of the country’s businessmen who have effectively paralyzed parliament.

5.      Efficient bond markets help to provide alternate avenues for savers from banks; this helps to provide a continuum of financing available in the markets. Currently in Asia, either companies can avail of bank financing, or they cannot – in which case they have no recourse but to put in more expensive equity. A functioning bond market would provide more specialist financing that is accessible to a wider group of borrowers.

6.      The penultimate reason and one that has been largely overlooked is – Japan. That country failed to take defaulting real estate companies by the horns in the late ’80s and early ‘90s owing to self-serving logic of avoiding a rapid decline in asset prices. As history has now shown, that decision to protect these companies from bankruptcy helped to create 20 years of zero to negative growth for the nation and made it the impotent economic sideshow it now is.

7.      The last reason is also one that may be controversial – but it is something I fervently believe in. Failure to repay without fear of consequences is arguably a “public bad” as inefficient businesses remain in operation and end up sucking what are essentially illegal public subsidies to remain in operation. Like small brush fires, bankruptcies help to prevent larger (forest fires) economic meltdowns later. I cannot help but think that if the Korean government had dealt with Daewoo and Ssangyong firmly, the country could have easily avoided its role in the 1997 crisis. Getting through bankruptcies in a systematic and ruthless fashion will help Asia unleash the forces of ‘creative destruction’ fully to the benefit of the region.


As a friend who is a restructuring lawyer in Asia mentioned recently – “Look at the proverbial table. The issuers of debt who are now defaulting are the same chaps who defaulted in 1997. That’s bad enough, but what’s more galling is that investors who are on the other side of the table are also the same institutions (if not the same individuals) who were at the table back then. No one learns anything in Asia”. He could have added that all other professionals – lawyers, financial advisers, bond traders and private investors in such bonds – are also pretty much the same from 1997.

The lack of progress in securing a workable template for debt restructuring in Asia means that borrowing costs remain overly high and in turn compel dependence on state policy levers and lending by state-controlled financial institutions. This is to the detriment of the region and its potentially dynamic future.

Many Chinese companies have offshore equity holding companies that also borrow. Since the operating companies are under Chinese jurisdiction, this means local debt in China is “real” debt while offshore debt borrowed in Hong Kong and then injected back into China is actually subordinated. Even so, for reasons of “face” or public reputation, if not financial ability, all these bonds have been honored until now

Under global laws, aircraft leasing companies typically have unfettered access to commercial aircraft when an event of default occurs. In this particular case though, India’s airport authorities among other parties pushed back against the seizure of aircraft; indirectly causing the losses to lenders

A ‘wilful defaulter’ is someone who has capacity but not willingness to pay. The sponsor of Kingfisher Airlines successfully removed the tag by arguing a technicality on the process rather than any debate about the merits, per my lawyer friend. Asia Times


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