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.