Biting the bullet

Ten years ago, banks in Thailand and the Philippines relaxed credit lines and issued soft loans to help companies weather the regional financial crisis. Those loans are now coming due and some borrowers are still not in a position to repay. By William Rhode

At the end of November, Thailand's Kasikornbank unveiled its sale of 11.8 billion baht ($39.7 million) in bad loans to US investment bank Morgan Stanley and South Africa's Standard Bank. The press release said the sale was to help the country's fourth largest lender ease management of its non-performing loans (NPLs) and cope with economic and political uncertainties.

Adit Laixuthai, Bangkok-based head of investor relations at the bank, says the sale was the end of a long battle to overcome an overwhelming bad-loan burden. "Our problems peaked in 1999, with 43% of our entire loan portfolio deemed non-performing," he says. "Since then, we've had to adopt several approaches to resolve the issue and clean up our balance sheet. This sale was the final step. Today, bad loans make up less than 5% of our loan portfolio."

Kasikornbank, formerly Thai Farmers Bank, is aiming for loan growth of 10–15% in 2008, due to a slowly improving economy. Analysts say the Thai economy will grow at 5%, up from 4% last year. The bank, which had outstanding loans of 704 billion baht at the end of October, expects its full-year results in late January to show lending growth of around 11–13% for 2007, thus meeting its target. The Thai bank's story is typical of many local lenders in the region. Rather than shut the door on beleaguered corporate borrowers in the wake of the Asian financial crisis, many instead extended credit lines and issued soft loans to help them weather the financial storm. Many of these loans were in bullet format – meaning the principal amount is repaid on the final maturity date rather than over the lifetime of the loan or bond – with low interest rates of 2–3%, usually with five- or-10 year maturities, say market participants.

Countering NPLs

"We've been invited by several Thai banks to see if we can do anything to help their clients repay restructured loans they took out after the 1997 crisis," says Dean Van Drasek, an executive director at hedge fund Lim Advisors in Hong Kong. "Many banks are constrained by regulations and the lack of a local market, and can't securitise these debts. The debtors are often too small to go public. So the only way to recover the loans is for the banks to bring in investment firms such as ours to see if we can help turn the companies around."

Kasikornbank's Laixuthai says bullet loans do not make up a large part of its NPL portfolio. "Putting outside private equity investors together with some of our borrowers has been a strategy we've used with success to manage our NPL problem," he says. "A collateral liquidation approach is a strategy we use to resolve bad loans."

Kaival Pongnontakul, head of investor relations at Krung Thai Bank in Bangkok, says the bank has made moves to help struggling debtors, including restructuring and offering haircuts. "One of the more successful alternatives is to urge our clients to seek strategic partners to turn the company around," says Pongnontakul.

Krung Thai Bank has a legacy of springing unpleasant NPL surprises on investors. The bank, Thailand's second largest in terms of assets, dropped a bombshell in 2004 when it unveiled that Thailand's central bank had forced it to reclassify more than $1 billion of loans as NPLs – even though they were still being paid. A total of 12% of Krung Thai Bank's loans, up from 8%, would be considered non-performing. The news sent its stock tumbling by more than a third.

The central bank, Bank of Thailand, later singled out Krung Thai Bank for lax lending standards, saying that it had financed several major projects of such dubious quality that the owners would probably not be able to repay the money. "They aggressively pursued loans without thinking a whole lot about what they were doing," says an analyst at a European bank in Bangkok. "Its hard to believe a billion dollars' worth of non-performing loans wasn't known about."

In November, Krung Thai Bank said it expected to add another 8 billion baht to its loan-loss provisions in the last six months of 2007 to comply with new accounting standards. Its NPL level rose to 10.2% at the end of June 2007 from 9.8% at the end of March.

Strategies for handling NPLs have included the establishment of asset management companies (AMCs). Some other options include recapitalisation, loan swaps and debt-for-debt exchange. "We also offer a discounted pay-off option in which the bank writes down loans to a market value," says Kasikornbank's Laixuthai.

In 1999, Kasikornbank set up Ploy Asset Management Company (AMC), which took control of NPLs from Phatra Thanakit Finance company, formerly a Kasikornbank subsidiary. Ploy AMC was liquidated at the end of 2005 because of difficulties recovering the debt. "AMCs were set up to deal with the worst part of the loan portfolio," says Laixuthai. "But there were problems with restructuring the debt. Even if the loans went into litigation, there was still a long delay before we could foreclose. Our hands were tied by the legal system."

Thailand's commercial banks have traditionally sought to resolve their bad loans themselves. Analysts say this approach has forced lenders to give politically connected borrowers a second or third chance rather than take them to court, where bankruptcy laws favour debtors. But many loans are rescheduled only to go bad again later. "In Thailand, the slippage rate is one of the highest," says the European banking analyst. A major rating agency estimates that 15% of restructured Thai loans go bad.

Philippine problems

In the Philippines, meanwhile, regional banks have resorted to seizing the assets of debtors unable to repay bullet loans. "A lot of companies who took bullet loans were struggling property companies," says Rose Marie Sotelo, head of treasury risk management at Land Bank of the Philippines in Manila. "We didn't reduce the interest charge, but if they were unable to repay when the loan came due, we accepted control of the real estate assets instead. It was the only logical solution when all other rehab options fail."

Other banks have had less success handling the bullet loan problem. Thailand's TMB Bank made a net loss of 20.6 billion baht in the first nine months of 2007, which led to an announcement in November that it would sell a 30% equity stake to Dutch financial group ING for $1 billion.

In November, Siam City Bank unveiled a sharp increase in thirdquarter losses and non-performing loans, although the bank says the losses stemmed from a move to tighten its classification standards. Siam City reported NPLs of 20.8 billion baht at the end of September, or 8% of total loans. This figure was nearly double the 12 billion baht or 4.7% of total loans reported at the end of June.

The Bank of Thailand, like the Philippine central bank, has pressured regional banks to tighten up their loan-classification criteria in time for the introduction of the new Basel II capital framework.

Thai banks were also required, in December 2006, to take initial steps in a phased adoption of a new international accounting standard called IAS 39. The standard involves a switch to future cashflow valuations of collateral that results in higher provisioning requirements for potential losses on NPLs. Under IAS 39, banks will be required to value NPLs based on their current economic value rather than their accounting value. This means Thai commercial banks will probably have to raise their provisions threefold to meet the requirements, says a March 2007 report entitled NPL Asia from consultancy PricewaterhouseCoopers (PwC).

"The BOT is continuing its push for NPL reductions via two measures which are due to be phased in over the next 12 months," the report says. "This is in support of their overall objective of reducing total NPLs to 2% by the end of 2007."

The first measure relates to how NPL figures are reported, and will allow banks to report net NPL figures – in other words, after an allowance of loan loss reserves – rather than the gross NPL figures currently reported. This measure, while effectively "window dressing" of the overall level of NPLs, say some parties, may help to present a better picture of a bank's asset quality.

The second measure comes with the phased implementation of IAS 39, which outlines new mandatory provisioning requirements for NPLs. The accounting standard requires that a 100% provision be taken on the difference between the outstanding balance of a loan and the present value of expected cashflow payments to be received from the borrower.

"The general view is that IAS 39 will require a number of banks to greatly increase their current reserve levels," says the PwC report. "This in turn should increase the attractiveness of NPL sales, as any loss on sale of an NPL is likely to be similar to the reserve that would be required to be affected under IAS 39."

Frank Janik, director of the distressed debt group at PwC in Bangkok and co-author of NPL Asia, says: "Up till now, price expectations among Thai banks have been high and have not generally been met by the market. However, as provisions increase [due to IAS 39], coupled with additional pressure from the BOT on NPL classification requirements, Thai banks are now likely to be more willing to sell at competitive market rates. That's why there's been a lot of activity recently."

Kasikornbank's Laixuthai says his bank went for the NPL sale because the pricing was right. "We were comfortable with the price we got for the portfolio," he says, but declines to reveal further details. PwC's Janik says Malaysia may be the next country to bite the bullet loan problem. "Malaysia is Asia's newest hot NPL market," he says. "We advised Maybank in the country's first NPL disposal since the issuance of guidelines for the disposal of NPLs by the Malaysian central bank in December 2005."

Maybank sold a portfolio of corporate NPLs, comprising almost 100 borrowers, with a face value of 2.2 billion ringgit ($670 million). In early January 2008, Maybank announced the sale of a second portfolio of loans, comprising more than 8,300 consumer loans, with a face value of Rm1.4 billion. "It is widely felt that the Maybank transaction represents the tip of the iceberg, with many institutions likely to bring NPL portfolios to market during 2008," says Janik.

While it has taken regional banks in Asia longer than expected to get to grips with the fallout from the 1997 financial crisis, their day of reckoning with bad loan portfolios has finally arrived.