Selling $17b in bad loans

Selling $17b in bad loans

For the next three months domestic and foreign investors will
be digging into the heap of financial ruins from the banking
collapse trying to find and purchase prize assets among the US$17
billion worth of dud loans put on sale on Monday by the
Indonesian Bank Restructuring Agency (IBRA).

The Rp 150 trillion worth of bad debt loans offered through
direct sales and auction are part of more than Rp 230 trillion in
non-performing loans (NPLs) IBRA took over from closed and
nationalized banks during the height of the banking crisis in
1998 and 1999.

The names of the 2,450 bad debtors, as announced by the agency
through ten-page advertisements last Friday include almost all
well-known conglomerates as well as medium-scale businesses. The
sizes of the loans range from Rp 5 billion to over Rp 750 billion
each and the debtors' operations cover all business areas from
property development, manufacturing, financial and trading
services to plantations.

This is the first massive asset sale program conducted by
IBRA, which seemed to be increasingly impatient with the snail's
pace of the asset disposal. Moreover, the agency is under strong
pressure to raise Rp 42.7 trillion in revenue for the state
budget this year.

The massive sale effort should be welcomed not only because of
the high transparency with which it is being conducted but also
as a concerted program to accelerate the asset disposal.

IBRA simply does not have the resources to manage, restructure
and collect such a huge number of bad loans, and the longer they
are held hostage at the agency the worse will be their quality.

The tricky part of the sale program, however, is that the bulk
of the NPLs have not been restructured. Yet more challenging is
that buyers will take over only bad loans and not the corporate
debtors, meaning that they will function only as creditors that
have to restructure or collect the loans without having the
authority to manage the debtors' business.

It is not quite clear yet as to how IBRA determined the final
amount of each bad loan, whether the amount also included
compound interests, including those from 1998, when the
prevailing interest rate was as high as 70 percent, and whether
debtors have accepted the final sum of their obligation.

Given these high risks, the special expertise and long time
needed to recover the bad loans, buyers would certainly be
willing to acquire the dud loans only at a fraction of their face
value. IBRA targets a recovery rate of 24 percent to 30 percent
but the market would decide the price.

The level of bidding price should not, however, be the only
criterion used by IBRA to select buyers, especially for such
commercial loans as auto and house mortgages that involved tens
of thousands of household borrowers. Throwing these small
borrowers into the hands of ruthless debt collectors would only
complicate things. IBRA should realize that quite a number of the
small loans went sour not because of the debtors' default but due
to the administrative confusion resulting from the dumping into
IBRA of distressed assets from closed and nationalized banks
during the height of the banking crisis.

Since most major domestic banks are still fragile and have yet
to build up resources and hone expertise in loan restructuring,
only a few of them would take a risk in acquiring the dud loans
as such investments could adversely affect their capital adequacy
ratio.

Not many domestic finance institutions have enough skills and
experience in polishing grimy assets -- prospecting for gold
inside the dump of bad loans -- especially if the process
requires complicated restructuring. Thailand and South Korean's
experience in auctioning off distressed assets from closed banks
shows that the big players in the distressed asset game are
strong, sound domestic non-bank finance companies and foreign
banks and investment companies or joint ventures between these
institutions.

Investors would face both big risks and a formidable task,
especially as most of the NPLs put on sale are business loans
that have yet to be restructured. The mere process of
restructuring the NPLs would be extremely formidable, requiring
negotiations with corporate debtors about new terms, new interest
rates and repayment schedules. And this process would be based on
business plans that are equally difficult to draw in view of the
fragile macroeconomic condition. Yet more challenging is that
investors will have to put up additional investments since
restructuring normally requires refinancing of the debtors'
business.

IBRA would therefore be well-advised not to put too much
weight on the level of bidding prices in selecting investors for
the NPLs. The sooner these distressed assets are released to
private investors the higher their recovery rate will be.