"This is a whole new world," says Anthony Root, a partner at debt restructuring specialists Milbank, Tweed, Hadley & McCloy. Asia is about to experience several years of workouts, refinancings, debt exchanges and bankruptcies in its corporate sector, he says. "The process has started in the US, but it will soon hit Asia like a tsunami."
Root introduces a fellow partner at the law firm, Dennis Dunne, who is over from the US where activity is already at fever-pitch and who is leading the Lehman Brothers' debt restructuring process. He is here to educate and prepare creditors in the region and perhaps also to stress how serious the problem might become in Asia.
A game of anticipation is taking place. Creditors and debtors alike are looking ahead to see where they might be exposed and are planning accordingly. This might involve pushing for pre-emptive refinancing—or at least prepare the ground through dialogue—or weighing up options such as various forms of debt exchange or even bankruptcy.
The most vulnerable companies according to Milbank are those run by Chinese entrepreneurs who raised cash offshore before the authorities closed that channel of "capital leakage", and Indonesian companies that put in place expensive pre-IPO financing.
In Asia, debt-for-debt swaps are likely to be the most favoured solution, rather than debt-for-equity, in order that company owners can avoid shareholder dilution, says Root, who has two decades of experience advising creditors and debtors in the region. Also, companies might follow Asia Aluminum's example and implement a reverse auction for outstanding bonds—although they will hope for a better result than the ill-fated Chinese company. Or, they may simply buy back bonds in the market place in so-called "street sweeps".
In a special report on March 18, Fitch Ratings studied 145 rated corporate issuers and found that in 2010 about half of these companies have refinancing requirements that are particularly reliant upon the strength of each country's banking system and continuing good banking relationships or other forms of support (for example, government support). The key is that this is bank debt, not bonds.
Fitch arrives at two broad conclusions. First, Asia is more reliant than Western markets on bank lending. As a result, the existing cash resources of certain companies could be rapidly depleted should the region's banks curtail lending, thereby substantially increasing the level of refinance risk. Fitch's sample companies have a combined $730 billion in outstanding debt, and 45% of this is sourced from banks, while the remainder from bonds and commercial paper. Furthermore, 54% of the total debt is scheduled for repayment or refinance by end-December 2010. Especially exposed are companies in China, Japan, South Korea and Taiwan, it says in the report, which is titled "Refinance Risk: Asia-Pacific Corporates".
Second, Fitch points to the ongoing need for indirect state support for the corporate sector through a state's ability and willingness to support the banking sector and through broad credit availability. However, Fitch says that any direct support by governments has the potential to lead to conflict with existing senior creditors.
But although Fitch is right to emphasise the preponderance of bank debt rather than bond interest and principal owed by Asian corporates, its analysis misses a key change in ownership of those bank loans that has taken place over the past six years. Since 2003, hedge funds, through their "special situations" arms, have been prolific buyers of loans, so they will be significant players when terms and covenants need to be renegotiated.
And from the middle of the decade, hedge funds in particular have been enthusiastic suppliers of what is effectively high-yielding bridge finance with restrictive covenants to private companies who planned to go public within three or four years. Repayment and possibly an equity stake for the lender would be the reward—but in the current environment, neither is likely.
There are other players too, such as private equity sponsors and agents with no direct interest in the loans—most egregiously holders of collateralised loan obligations and other structures.
Also, there are many and variable insolvency regimes in Asia, with untested and unpredictable bankruptcy regimes in key countries such as China and Indonesia. Even Hong Kong has its unique characteristics, for instance unlike in the US, it doesn't preserve a going concern value for companies.
In any case, say the Milbank partners, it is essential for creditors to identify what they call "fulcrum securities", which will give them power and influence, or leverage, to work out the most satisfactory solution.
Anthony Root will be speaking at the "Distressed & Troubled Asset Investing Summit—Global Opportunities for Asian Investors", which will be hosted by FinanceAsia and AsianInvestor and held at the Island Shangri-La hotel in Hong Kong on April 28-29, 2009. Please visit www.financeasia.com/distressed for details.