First the meltdown: then the restructuring. Throughout Thailand, the private sector is entering an era of far-reaching change - cultural, commercial, legal and financial. The old order has had its day. Who will be the winners and the losers in the new order?
In the first of a series of special features on Asian economies in the wake of the meltdown, and the wave of corporate and financial restructuring that is getting underway, Mark B Johnson reports from Thailand.
The huge task of renegotiating the terms of Thailand's massive private sector debt burden is in full swing. Thailand's economy is still deep in crisis and it is clear that there is no longer room for intransigence among the country's private sector debtors and creditors.
The new Bank of Thailand governor, Chatumongkul Sanakul, has recently indicated that the misery must be divided equitably and that compromise will be needed from all sides.
In mid-May, Banthoon Lamsam, chairman of the Thai Bankers' Association and president of Thai Farmers Bank, said much the same thing: "The debtors will take a hit and so will the creditors. Otherwise real restructuring cannot take place."
The months ahead will tell whether negotiations succeed or whether Thailand's courts will be swamped with demands for supervised settlements under the country's new bankruptcy law.
Foreign creditors have no choice other than to cut a deal with their hard-pressed debtors. They are fighting their corner to win the best possible terms in each renegotiation and refinancing. But even the most optimistic foreign creditors know that they will have to share the same fate as the local Thai creditors and write off large percentages of their loans.
Faced with usurious interest rates and a liquidity stranglehold, Thai owners and management must face the fact that the price they will likely have to pay for fresh foreign capital is the loss of absolute control of their companies.
The new government and the central bank have already sent this message to the financial institutions. Following their huge international share placements, foreign shareholders will demand that Bangkok Bank and Thai Farmers Bank become more transparent in their dealings.
The owners of smaller banks such as Thai Danu and Bank of Asia have already sold out control, to DBS and ABN Amro respectively.
Foreign creditors are increasingly demanding that debtors open their doors to fresh foreign equity and management expertise as a prerequisite for agreeing to reschedule and write down their loans. Pure replacement bank finance will remain hard to locate and, other than in exceptional cases, more expensive than existing facilities.
Aside from high yields, new bond investors are expected to demand more equity and equity-linked kickers before they will consider taking private sector risk.
This is clearly highlighted in the first major private sector recapitalisation that has so far emerged from Thailand, for Nakornthai Strip Mill PCL (see box on page 20).
One of the few ways companies can access cheaper capital is to raise debt securitised on export receivables. But in these cases, although the owners may still retain control of the equity, they will lose direct control of their cashflows (see box on page 22).
To gain negotiating leeway debtors are trying to raise cash by divesting non-core businesses and refocus scarce capital and management resource on core operations.
But, as with the country's largest conglomerate - the Charoen Pokphand (CP) group of companies - the cash that companies can raise by selling assets pales in comparison to the debts weighing on their balance sheets (see box on page 18).
Meanwhile the strongest foreign banks and investment houses remain committed to the region. They are using this crisis to enhance their relationships with - and their power over - what will emerge as the cream of the country's restructured and revitalised private sector.
The Chuan government, driven by a new dynamism of national responsibility and also rallied by the IMF, is working feverishly to establish the legal, regulatory and cultural frame work for the corporate restructuring game to be played out fairly.
The Thai private sector could owe as much as $70bn in foreign denominated debt (let alone the vast oceans of domestic currency borrowings).
Bankers estimate that as much as 50% of the more than $6bn in foreign currency loans due to be repaid by the end of June will have to be rolled over.
A recent report by the deputy minister of finance calculates the cost of the crisis to Thailand's private sector to be more than $130bn in terms of real losses and deflated securities values.
Analysts estimate that around $8bn of the Thai private sector exposure is in the international public securities markets (this includes equity-linked issues).
A recent report by Bankers Trust highlighted at least 20 Thai convertible bonds that are already in default. Most bankers predict that many more will default unless radical recapitalisation moves are made in time.
Not all the foreign denominated debt is owed to foreign banks and investors. A significant portion of the dollar loans, especially for the unproductive property development sector, was disbursed by asset-hungry local banks and finance companies. But most of those local operations had in turn borrowed those dollars (or Swiss francs, yen, Deutschmarks or any other currency) on the international capital markets.
The top tier of US and European banks have generally emerged with a far less precarious exposure today than the local banks and the second and third tiers of international banks and financial institutions.
Foreign banks operating BIBFs and branches in Bangkok - such as Citibank, Deutsche Bank and ABN Amro - privately report very modest non-performing loans.
But during the boom times of the early 1990s, a myriad of lesser name banks and more obscure financial institutions from around the globe suddenly awoke to the miracle that seemed to be happening in Thailand.
Hundreds of local borrowers were courted by dozens of lenders to borrow money. These lenders were desperate for the business and lent to owners and businesses with little or no track record and against assets or projects that were, to say the least, less than prime.
The Japanese banks, flush with cheap yen and eager to support the flow of foreign direct investment to Thailand, also racked up a massive exposure to Thailand - much of which, along with their huge problems at home, they are now struggling to sort out.
In the good times, both local and international securities firms were busy fuelling the flames of excess. Supposedly reputable international intermediaries produced excessively bullish economic forecasts.
In hindsight, it is clear that far too many earnings projections were produced by over-enthusiastic research analysts caught up in the excitement.
The spoils of this feeding frenzy for the international banks and securities houses were lucrative fees for underwriting and distributing billions of dollars worth of foreign syndicated loans, bonds, convertibles and share placements. Today's reality is that virtually the whole of Thailand's private sector is technically in breach of the financial coverage covenants on its debts - or soon will be.
Charoen Pokphand's vice president, Sarasin Viraphol, was reported recently as stating that CP, Thailand's largest conglomerate, was "like the country in its need to refinance and restructure". The same could be said for virtually every private sector firm.
Moreover, creditors need to realise that a large portion of the corporate debt will never be repaid. More and more companies are closing each week. Stock prices are depressed and the stockmarket is illiquid. There is little or no equity capital available in Thailand to refloat the economy.
While the fragile banking system is being forced by the Bank of Thailand to reform and recapitalise, liquidity remains extremely tight. Interest rates are close to all time highs and the financial sector is unprepared to take additional risks on private sector lending.
This is squeezing even those companies with strong cashflows, or at least what would be strong cashflows if they could access working capital. Many exporters, even those enjoying strong overseas demand, cannot obtain the normal banking facilities to complete their orders.
Most of the funds to drive the export sector are only available from the multinationals, from the export-import banks and Industrial Finance Corporation of Thailand (IFCT).
Some of the private sector corporations are, quite simply, grossly over-leveraged; some have potentially fatal mis-matches on cashflows and debt maturities. All of them have been caught by the collapse of the Thai currency since mid-1997; and the majority of them have over-invested and over-extended their management resources.
The latest preoccupation in Bangkok is to unravel the massive private sector debt crisis caused by the previous decade of such surfeit and over-indulgence.
As a consequence foreign corporate finance specialists have been competing to win lucrative restructuring advisory mandates from the scores of Thai companies with devastated balance sheets.
These advisers are in the middle of a corporate game of chess between debtors and creditors, each determined to carve out the best possible deals for themselves.
The creativity of international investment bankers and securities houses is also being tested to the limit as they struggle to find ways of attracting foreign lenders and investors back into Thai private sector risk.
The game will inevitably take several years to play out, but the end of it will inevitably see a new private sector landscape emerge in Thailand.
The strong international lenders and investment houses will consolidate their positions as financiers and advisers to a revitalised and refocused corporate hierarchy that will be far more clearly defined as first, second and third divisions. Corporate credit worthiness and management integrity will move ever more to the fore for local and foreign lenders.
The corporate sector also has to raise fresh equity from overseas. The price for this is a newly emboldened foreign investor who will demand a greater voice in company investment decisions.
This type of investor will, along with local minority shareholders, also will be greater empowered by the law and by compliance enforcement from the regulatory bodies. Foreign bond investors will increasingly demand to share in the equity upside as the price for what they see as having rescued the debtor company.
Most of the local banks will have to sell out majority control to international banks. Even the biggest, such as Thai Farmers Bank and Bangkok Bank, will have to change.
Their owners will be forced to give up majority control and will have their former independence curtailed for many years by a combination of the thirst for capital and supervision from a reinvigorated Bank of Thailand.
The end of the game should also see a new legal and regulatory framework that could put Thailand at the top of the league compared with Malaysia, Indonesia and the Philippines.
Enforcement will then be the key and the effectiveness of that will only become clear over time. For the moment, most international bankers and investors are prepared to believe the initiatives taking place in Thailand are genuine.
These days in Thailand a new wave of thoughtful, eloquent politicians and technocrats have come to the forefront. Spurred on by the IMF, they appear determined to create the regulatory and enforcement mechanisms for a more fair system of creditors and the rights of minority shareholders.
At the forefront of this new drive is prime minister Chuan Leekpai - whose engaging cocktail of humility, intelligence, resoluteness, foresight and asceticism have won respect from the Thai people and plaudits from the international political and financial community.
Chuan's right hand man is his chosen tough technocrat, finance minister Tarrin Nimmanahaeminda, whose unwavering adherence to legal and market reform has surprised even some of the more cynical of the old hand foreign securities analysts.
The latest Bank of Thailand rules announced late March will force Thai banks by the year 2000 to adhere to regulations almost as tough as for commercial banks in fully developed economies.
These new rules are urgently forcing these banks to find new capital or be taken over by the authorities. But there is little or no fresh capital available in Thailand.
"This crisis is proving the perfect opportunity for the political reformers to demand that the old oligarchy of big banking families sells down or sells out and institutes arms-length professional management," says the head of a leading European bank operating in Thailand. "This is now very popular in Thailand - after all financial services' firms are supposed to be custodians of public money. Financial sector reform is being conducted by zealous politicians under the banners of people power, transparency and accountability."
The Bank of Thailand is also working to reprivatise the four commercial banks - Bangkok Metropolitan Bank, Bangkok Bank of Commerce, Siam City Bank and First Bangkok City Bank. These were taken into the central bank's ownership through the conversion of some Baht87bn ($2.2bn) in loans to equity by the bank's Financial Institutions Development Fund (FIDF). JP Morgan has been hired to advise on and execute this process.
The Financial Sector Restructuring Authority (FRA) is determined to reprivatise the Baht860bn ($21.5bn) of assets of the 56 closed finance and securities companies with great urgency.
Advised by Lehman Brothers, the FRA is selling assets to local and foreign investors at auctions. By the end of the year the FRA hopes to have achieved values of around 60% of the assets' face value. Some of these assets will be repackaged as asset-backed securities, such as mortgages and hire purchase loans.
"There is no time to linger as we want to return these assets to the private sector where they belong," says Vicharat Vichit-Vadakan, secretary-general of the FRA.
"We know that not all the regulatory and legal reforms are yet in place, but we want the marketplace to determine the value of the assets while the politicians and legislators make all the necessary reforms. They will do this in the months ahead during our disposal process."
At the same time the Stock Exchange of Thailand (SET) is steadily delisting companies which have failed to announce transactions, which have been slow to restructure or which have appeared to abuse minority shareholders' rights.
"We are starting to become really serious about corporate governance. At the same time there is a popular wave in the country to demand that the abuses of the past do not happen again," says Amaret Sila-on, chairman of both the FRA and the SET.
The new government is sounding loud alarm bells to warn people in public office that they will be held accountable for their actions. Earlier this month former Bank of Thailand governor, Chaiyawat Wibulswasdi, announced his resignation following a scathing report on Bank of Thailand practices leading up to the current financial crisis.
The report was commissioned by Tarrin's finance ministry and prepared by a special commission led by another former central bank governor, Nukul Prachuabmoh.
The new central bank governor is Chatumongkul Sonakul, a former finance ministry permanent secretary. He was promoted by prime minister Chuan Leekpai for being a man of principle able to set about the tough reforms demanded by the Nukul report.
Almost immediately he announced fresh proposals to curb the powers of the central bank governor, develop financial mechanisms to support the Thai private sector and introduce new laws to facilitate the prosecution of financial wrongdoers.
In most fully developed economies a proper bankruptcy law will allow the debtors a window of opportunity to reach a fair agreement with creditors; meanwhile the business can raise new credits that will rank at least pari passu with existing creditors. If this agreement is not forthcoming the creditors will then call for foreclosure.
Thailand does not yet have these procedures and practices in place. Until it does - and until it is seen to be implemented equitably by the authorities and by the judiciary - the creditors, both local and foreign, will remain in a position of weakness, both legally and culturally.
However, the first major step has was taken on April 1 when the King of Thailand signed the final draft of the new bankruptcy law which became statute on April 10.
The Thai partner and bankruptcy specialist at the Bangkok branch of one British law firm says: "The new generation of educated Thai people in their 30s and 40s now have more say than before. We are determined that the middle and lower classes in our country should never again suffer from the abuses, corruption and speculation of a few prominent business and political families."
The new Bankruptcy Act is a key element in the restructuring of Thailand's corporate and financial sectors. Similar to the US Chapter 11 provisions it allows debtors to file for bankruptcy and still raise new credit and operate their businesses.
Under the former bankruptcy law it was virtually illegal for lenders to supply additional facilities to companies that could later have been proven to be technically insolvent at the time the funds were disbursed. Moreover, the last lenders would technically have ranked inferior to all other creditors.
Under the new law, at the least, new creditors will rank pari passu with existing creditors. Moreover, as the act is worded, lawyers believe that the judiciary could have the discretion to rank new creditors ahead of other existing creditors (aside from those with collateral).
But all these new initiatives will still leave both practical hurdles and significant legal issues to be overcome, especially for foreign creditors.
The new Bankruptcy Act, proactive and far-reaching as it may be, is as yet impotent because Thailand does not yet have a formal foreclosure law or established liquidation process.
If the shareholders and management of a company with delinquent debts do not propose a restructuring plan that is endorsed by the creditors then the creditors should have recourse to the courts.
In the last resort the court may decide to allow the creditors to foreclose on the assets of the company, thereby reducing share holders to their appropriate status - last in line for what is left over.
To address this key issue, work continues behind the scenes with the IMF assisting the politicians, technocrats and judiciary in drafting new foreclosure procedures and amending the laws to allow the process be executed efficiently.
In practical terms, however, many lawyers and bankers maintain that for the bankruptcy and foreclosure procedures to work, up to 700 judges will have to be trained. And these will also have to remain untainted by corruption.
This could be a problem. One foreign banker says: "Most of these judges simply do not exist. And, even if they did, they would not be sufficiently qualified or experienced to opine on such technical matters, especially when it comes to assessment of values of assets and businesses."
Vicharat at the FRA understands these concerns. He told Euroweek recently: "I can assure you this matter is under consideration as we see that the new laws will need to be implemented in an even-handed and transparent manner."
One proposal is for the establishment of special courts into which financial sector and business specialists would be drafted on a case by case basis. In legal terms there is also a question mark hanging over the ability of foreign creditors to seize assets even following a successful decision in favour of foreclosure.
The core assets that would be seized will often include land and property. However, there are no signs that the Thai government intends to tackle this issue - at the moment foreigners cannot freely own land or property in Thailand.
This particular issue is potentially a political hot potato. There are clearly limits to how far the new wave of reformers will go. When asked about the possibility of a change to the Alien Land Law, the FRA's Amaret stated his view unequivocally: "We do not yet see any quick changes coming in this regard - it is politically sensitive and this is a very emotional issue for the Thai people."
A compromise proposed by some bankers and lawyers would be to allow foreign ownership of land and property that has been seized in a foreclosure or liquidation process.
The foreign party would then be allowed to hold those assets until the earlier of, for example, 10 years from seizure or the date at which a valuation can be achieved in auction sufficient to redeem the loan facility plus accrued interest.
The central bank is also at the forefront of other legal, accounting and tax initiatives that will remove many of the current impediments to corporate and restructuring exercises.
The Bank of Thailand - working with the Ministry of Finance, the Thai Bankers' Association, the Association of Finance Companies, foreign creditors and the Revenue Department - announced on May 20 that details of some of these initiatives would be released by June 15. It is uncertain, however, whether sensitive taxation issues will have been resolved by that time.
Related strictly to private sector restructuring exercises, the key issues should include: the relaxation of capital gains laws on asset transfers; the removal or decrease of land transfer taxes; rules to facilitate debt for equity swaps and debt for collateral swaps; rules for revaluation of collateral to reflect current values; guidelines for classification of debtor companies; and guidelines for reclassification of non-performing loans as performing during workout proceedings.
Aside from legal, regulatory and compliance reforms, the government's drive to reform the banking sector is perhaps the key element that will enable Thailand's private sector foreign creditors to extend, reschedule and renegotiate their loans.
Analysts estimate that the Bank of Thailand's recent loan classification and provisioning requirements that become effective over the next two years will force the commercial banking sector to raise an additional Baht600bn ($15bn) in fresh capital. Some analysts estimate that if the new rules were in effect today some 60% of the Thai banks' assets would be classified as non-performing.
If this capital is to be raised in the next two to three years, at least 70% of this new money will have to come from foreign strategic and financial investors, say analysts.
If the banks do not recapitalise rapidly and transparently, the central bank has said that it will seize them and sell them off later, presumably to foreign investors as they are the only real source of fresh capital.
For the banks to raise this new money the Bank of Thailand will need to be seen to ruthlessly enforce compliance to the new rules and adherence to international standards of corporate governance. The government will need to ensure that all the new laws and procedures are in place and work.
Since the central bank announced that foreigners could hold more than 51% of commercial banks for up to 10 years there have been several deals announced and more are pending.
The research head of a US investment bank in Bangkok states "We expect most of the local commercial banks to end up in the hands of foreign strategic investors by the time this process is completed. The implications for the banking sector and the way business is conducted will be enormous."
Although the Lamsam family still retains effective control of Thai Farmers Bank, their absolute control has probably been diminished for ever with their recent $857m international placement. The same will be the case in the dilution of the Sophonpanich family's control of Bangkok Bank through the recent new issue of close to $1bn.
Moreover, the latest round of banking regulations announced after the Thai Farmers Bank placement will, banking analysts predict, require the bank to undertake a second recapitalisation next year.
Knowing at least some of Bangkok Bank's exposure to the crippled private sector, analysts expect that true compliance to the new central bank regulations will, before too long, force the bank to sell more than 50% to foreign investors.
In many cases the incumbent owners of several banks are ready to give up control in exchange for the infusion of fresh equity. This was the case when Bank of Asia sold out to ABN Amro and Thai Danu Bank to Singapore's DBS Bank and related Singapore government linked entities.
In other cases owners are reluctant to be diluted from their controlling position or cannot agree on the price for the loss of control. Sometimes, even if these issues can be resolved, when due diligence starts, the balance sheet is found to be devastated or proper disclosure does not take place.
Analysts believe the latter may have been the case in the landmark withdrawal by Citibank from a deal to buy First Bangkok City Bank, one of the four banks currently held by the FIDF.
Although Citibank prefers not to comment on the reason for the collapse of discussions, observers point to the reluctance of targets to open their books and allow new strategic investors to make a realistic assessment of value.
"You can guess that what some banks might have to hide is a shipwrecked balance sheet and masses of questionable deals through nominees and nominees of nominees," says a leading local foreign banker.
Aside from Citibank, other international names scouting the market include Bank of Nova Scotia, Standard Chartered and Singapore's Keppel Bank. Most interested parties privately acknowledge that it is extremely difficult to reach agreement on pricing.
"Owners believe that their banks will be worth what they were before and foreign banks believe that they will only be highly valued if they gain foreign management and fresh foreign capital," says a foreign bank analyst. "So there is a major disagreement between the parties over pricing levels."
TFB's president, Banthoon Lamsam - who is also chairman of the Thai Bankers' Association - appears determined to push the smaller banks and finance companies to surrender to takeovers for the sake of the stability of the financial system.
The central bank took over seven finance firms on May 18 (including Union Asia Finance and Nava Finance). This has led observers to believe that the pressure is being increased on recalcitrant owners of financial institutions to restructure and recapitalise and to accept deals now rather than wait.
In the aftermath of this, Banthoon - referring to two of the smaller privately owned banks that have not yet concluded restructuring deals, Nakornthon Bank and Union Bank - was quoted in the Business Day newspaper as saying: "In fact, the two banks could have completed their capital increase plans a long time ago if they had accepted the prices offered by foreign investors."
The implications for Thailand's banking sector can be distilled into a few simple platitudes. As foreign banks take over the local banks they will attempt to institute credit control procedures and standards more common in the developed economies.
As risk assessment begins to predominate over relationship lending, only those borrowers with strong credit standing, strong management and transparent corporate dealings and financial disclosure will have steady access to credit.
As the weaker companies and weaker management teams struggle to obtain credit, more and more of those companies and owners will close or be forced to close either by competitive forces or by the mechanisms of bankruptcy proceedings and foreclosure.
This theory of the development of the Thai financial system and corporate sector can, however, be derailed by many factors. The cynics, generally those foreign bankers or investors that have had a long exposure to Thailand, argue that nothing will really change.
"The Thais have this enormous capacity to soak up all the pressures from the outside world and never really change their modus operandi," says one banker.
Others argue that some big business families and corrupt politicians are just waiting until the good times come round again. "Don't forget that memories are always shortened and ethics rapidly weakened by a rising stockmarket and easy money," warns one local Thai technocrat.
With such enormous problems besetting the private sector, owners and management are beginning to admit that many of their investment decisions in the past have been at best ill-judged and at worst foolhardy.
Similarly, more of the enlightened local bankers admit that their criteria for lending in the past was often questionable and occasionally irresponsible.
Some of the Thai political and business leaders are now prepared openly to accept responsibility for the current economic and financial crisis. However this is generally accompanied with the caveat that it was the flood of money from outside Thailand that was at the root cause of the implosion.
Thai companies and Thai banks are only partly responsible for the current crisis. Endemic corruption at the top levels of government and the civil service set a poor example to the business community and to the people on the street. Short termism and quick money became the norm.
Some also believe that local financial institutions were also partly victims. "The real problems date back to the opening of the economy in 1993," says the executive director of one of the country's leading private banks. "Local financial institutions were not ready for the competition from the BIBFs, from local branches of the foreign banks and from the offshore banks and investors.
"Thailand was stuffed with money from overseas, and the banks and the finance companies then stuffed companies and individuals with that same money. The result was a contagion of optimism. From the top to the bottom money was spent recklessly, land speculation was virulent, the stockmarket became a casino and real productive investment was seldom based on realistic assessments of risk and return."
Throughout 1996 and most of 1997 the majority of company owners, directors and local bankers remained in denial. They refused point blank to take responsibility for cleaning up their balance sheets and restoring investor and creditor confidence in their companies.
Although there is a change in mentality taking place, many foreign bankers and investors argue that if owners and boards of directors fail to take the necessary steps then Thailand's private sector crisis could continue for years to come.
"The psychology must change," says one local functionary. "It's no good trying to put a plaster on a leg with gangrene. Better cut it off before the whole body is rotten."
What the smart owners and management realise is that rationalisation will take place whether they like it or not. The marketplace and the new breed of Thai politicians and technocrats will determine who survives and who falls aside.
Inevitably, those companies and banks that will prosper in the next millennium will be those that take the tough decisions today.
Says the executive vice president of one leading local bank: "One day owners and directors will realise that when a company is effectively bankrupt it should be the creditors which have the rights to salvage what they can. That day is coming." EW