Korean-style restructuring system reaching its limit

Posted on : 2016-04-27 17:15 KST Modified on : 2019-10-19 20:29 KST
Composition of creditors group is complicated, and may need change toward bank initiated model
The STX Offshore & Shipbuilding yard in Changwon. STX is currently undergoing restructuring and its overseas assets are being sold off. (by Lee Jeong-yong
The STX Offshore & Shipbuilding yard in Changwon. STX is currently undergoing restructuring and its overseas assets are being sold off. (by Lee Jeong-yong

On Apr. 13, the Wall Street Journal ran a story on its front page about how Peabody Energy, the US’s biggest coal company, had filed for bankruptcy protection in the US Bankruptcy Court in Missouri. The article described the company’s financial troubles and the situation of the industry. But it did not say anything about a meeting of the banks that had lent the company money or about the government making an effort to help the company get back on its feet.

This is very different from the way things work in South Korea. The recent push for restructuring in South Korea began with remarks by Deputy Prime Minister and Finance Minister Yoo Il-ho.

“The government will take charge of restructuring ourselves, and we will speed things up,” Yoo said during a press conference in Washington on Apr. 14. Since then, coverage of restructuring in the South Korean media has always mentioned the group of creditors (generally the Korea Development Bank), high-ranking government officials and even the leaders of the opposition parties.

This difference results from the fact that the approaches to restructuring taken by the US and South Korea are themselves different. In the US, restructuring is completely left to the market, and not only the government but even banks do not usually get involved.

When struggling companies sell off their assets, these are typically purchased by private equity funds. And when companies run out of options for overcoming their problems, they file for bankruptcy or restitution with the courts.

In South Korea, restructuring focuses on the group of creditors. This group plays a supervisory role, and decision-making power is allotted to the banks according to the amount they are owed. All the details are worked out in this meeting, from providing new funds to deciding which assets to liquidate, which managers to appoint, and how to hold the primary stockholders responsible.

To be sure, the blueprint for restructuring a large corporation is drawn by the government. The outline of the recent restructuring of the shipping and shipbuilding industries took shape in a meeting at the Blue House attended by high-ranking officials including the Minister of Strategy and Finance, the head of the Financial Supervisory Commission, the Minister of Oceans and Fisheries and the Minister of Employment and Labor.

While there have occasionally been objections to the leading role that creditors (and the government) have played in restructuring, this approach has been employed without any major hitches since the Asian Financial Crisis in 1997. The problem, though, is that it is now reaching its limits.

A considerable number of experts agree that the “workout” system, in which companies try to work through their problems, and the “autonomous agreement” system, in which creditors jointly supervise restructuring, are steadily becoming less effective. This is prompting the prediction that the current restructuring of South Korea‘s five vulnerable industries is likely to be a case of “the squeaky wheel getting the grease.”

Most importantly, the composition of the group of creditors has become more complex. With Hyundai Merchant Marine, banks account for less than half of the group of creditors, with the rest consisting of individual and foreign investors. This means that the conditions are not in place for a few banks to put their heads together and push ahead with the restructuring.

“When we restructured the Daewoo Group, corporate bonds only accounted for 5% of the total loans. The banks paid these 5% loans on behalf of the group and were able to easily draft a restructuring plan,” said a source in the finance industry who was involved in restructuring during the Asian Financial Crisis. “But with the companies that are struggling today, corporate bonds make up more than half of their liabilities.”

During restructuring, agreement among creditors about how to divide losses and how much new funding to provide is of critical importance, but under the current system it is difficult to reach such an agreement. As the number of creditors increases, it is inevitable that creditors’ meetings will move more slowly.

And while the advantages of creditor-led restructuring are losing their luster, the disadvantages are coming into the spotlight. The first of these disadvantages is the tendency of banking officials to protect themselves.

Not only government banks but also commercial banks maintain huge departments dedicated to improving corporate structure. “There’s a widespread sense that it’s better to hold on to nonperforming loans than to sell these and clear the books,” said a former vice president of a commercial bank.

Nonperforming loans can only be sold at a big discount from their original price, which is sure to prompt questions about whether this price was appropriate. Worried about having to answer such questions, bank employees and department heads end up deciding to hold on to these loans instead of selling them, the source said.

The increasing complexity of industries themselves is also limiting the effectiveness of the current system. Groups of creditors essentially take a direct role in management, even assigning managers for companies undergoing restructuring. At Daewoo Shipbuilding and Marine Engineering, the chief financial officer (CFO) was assigned by the Korea Development Bank, the main creditor. (The CFO is Kim Gap-jung, former vice president of the Korea Development Bank.)

The problem is that the group of creditors does not have the expertise to manage a huge shipyard. Since these managers do not have the ability to clearly distinguish profitable business divisions from unprofitable ones, restructuring is slow to get off the ground.

“Managers should be assigned who have a good understanding of the industry in question, but the people who are currently managing the companies being restructured were appointed through their connections with the government and state-run banks,” said a researcher at a government institute.

“The courts will play a more important role in restructuring in the future,” said a high-ranking official at the Ministry of Strategy and Finance.

“We need to build a market for nonperforming corporate loans so that banks can easily liquidate their bad loans,” said the former commercial bank vice president.

By Kim Kyung-rok, staff reporter

Please direct questions or comments to [english@hani.co.kr]

 

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