12 Restructuring Korean Banks’ Short-Term Debts
- David Coe, and Se-Jik Kim
- Published Date:
- September 2002
Woochan Kim and Yangho Byeon*
This paper provides detailed accounts of the Korean banks’ debt restructuring process in the first half of 1998. This event deserves our attention not only because it significantly relieved the Korean economy of its immediate shortages of foreign exchange, but also because it provided a turning point from which the Korean economy started to regain foreign investors’ confidence, and thus to overcome the crisis. Reflection upon this event also has a special meaning at the time of writing as Korean banks have recently repaid in full the debts that had been extended up to three years in early 1998.
The objective of this study is fourfold. First, the paper aims to serve as a future reference for those who might later face a similar problem. Although the Korean experience was unique in many regards and is not likely to be replicated by other countries, we believe that the knowledge of this event will better equip those facing similar problems. To this end, the paper turned out to be a case study with detailed accounts of events, explanations of major decisions, and the logic behind them, and some anecdotes. In particular, we tried to cover in detail the administrative aspects, which might be more useful for those who are actually implementing a debt-restructuring process. Appendix 1 shows the list of information sources used in this paper.
Second, the paper aims to give a detailed account from the debtors’ perspective. Existing publications seem to have covered the event from the perspective of creditors or of international organizations. Such approaches, however, left out many important aspects of the debt restructuring process. The paper pays special attention to issues such as how the government set the strategy to win favorable terms from the creditors, how the government organized its delegation in the midst of a power shift from the old administration to the new, and what considerations were taken when it determined its positions on various negotiation items.
Third, the paper aims to uncover an important aspect of the debt restructuring process that is not well known to outsiders. The agreement reached in New York in late January 1998 was no doubt an important step forward for both the debtor and the creditor. However, the agreement was tentative and only involved thirteen creditors. During the following two months, it was up to the Korean government to persuade the rest of the creditors to join the maturity extension program. The paper provides information about this endeavor.
Lastly, the paper attempts to provide some useful statistics regarding government guarantees and the effectiveness of the debt exchange program. In particular, we analyze if the moral hazard problem reemerged among creditors and debtors due to government guarantee. We also analyze if restructuring of bank debts triggered a withdrawal of credit from the corporate sector, and if small creditors or creditors that were not involved in the New York negotiation had a lower participation rate in the debt exchange program than others.
Events Running Up to the New York Negotiation
In mid-December 1997, the US$57 billion rescue package put together by the international community did little to restore investor confidence in Korea. To add insult to injury, international rating agencies went into a frenzy of competitive downgrading. In addition, given the large but uncertain amounts of looming non-performing loans, banks had extreme difficulty in rolling over short-term debts, let alone obtaining new loans. To prevent a series of bank defaults, the Bank of Korea had been lending foreign exchange to ailing banks, reducing official reserves. On December 18, usable foreign exchange reserves only amounted to US$4 billion, down from US$22 billion at the end of October.
The domestic political scene exacerbated the financial crisis. On December 18, a new president had been elected but would not take office until February 25, 1998. Until then, the defeated government remained in charge. To foreigners, it was not clear who was in charge of the economy. With a lower sovereign credit rating, government bond issuance became a remote possibility. Instead, it became more practical and urgent to extend the maturity of short-term debt falling due and to work with international credit rating agencies to forestall any additional downgrades.
Government Starts to Take Action
In mid-December 1997, discussions took place between Man-Soo Kang, Vice Minister of Finance and Economy and the heads of foreign bank branches in Seoul on ways to roll over short-term credit lines to Korean banks. The meetings, however, could not lead to any concrete results since Seoul branches did not have enough influence over their headquarters regarding the decision to roll over.
On December 19, to prepare for meetings with major credit rating agencies in mid-January, the Korean government (hereafter government) appointed Goldman Sachs & Co. and Salomon Smith Barney as its joint financial advisors. They were to provide advice on the possible issuance of government bonds, although they were not yet appointed as official lead managers. Gerald E. Corrigan, Managing Director of Goldman Sachs & Co. and former New York Federal Reserve Bank chairman, was also invited to act as strategic adviser to Chang-Yeul Lim, Deputy Prime Minister and Minister of Finance and Economy (hereafter Deputy Prime Minister), on reform of the financial system.
On December 22, 1997, the Korean National Assembly approved a bill submitted by the government to provide a guarantee for foreign currency debt that had been incurred in 1997 and would be incurred in 1998 by domestic banks. According to a statement in the bill, the guarantee would help alleviate the nation-wide foreign exchange liquidity problem by facilitating new borrowings (including rollovers) by domestic banks. The size of the guarantee was limited to a maximum of US$20 billion plus interest, and the maturity was limited to three years. Thirty-three domestic banks, including state-owned banks and specialized banks, were eligible to apply for the guarantee. The Bank of Korea and merchant banks, however, were not. On the same day, the National Assembly also approved the issuance of sovereign bonds up to a maximum of US$10 billion by the government.
International Community Makes a Move1
Concerned that the announcement of a US$57 billion rescue package put together by the international community did not immediately improve confidence toward Korea, the U.S. Treasury wanted to make an early disbursement. But this could not be done before the private-sector banks had rolled over their credit to Korean banks. In response to the request made by the U.S. Treasury and the IMF, William McDonough, Chairman of the Federal Reserve Bank of New York, convened a meeting in New York on December 22, 1997, to convince key U.S. banks to roll over their maturing inter-bank loans to Korean banks.
During this meeting, it was emphasized that failure to roll over credit would trigger a systemic risk to the world financial system, and that if agreement were reached, the official community would extend additional accelerated resources to the Korean government. On December 24, Christmas Eve, a second meeting was convened. McDonough repeated the official view that the banks should agree to roll over their credit. The banks agreed.
A similar meeting took place in London. The Bank of England summoned a meeting on Christmas Eve and it was agreed that HSBC would act as the country coordinator. The U.K. banks’ position was to roll over short-term credit until March 31, provided every creditor agreed to do the same. In Frankfurt, the Germans had some trouble coordinating as they had more banks lending to Korea than the British. The first meeting between German banks and the Bundesbank took place on December 29. The German position was to roll over credits falling due by the end of 1997 for an extra month.
On December 24, 1997, the participating countries in the supplemental financial support package for Korea announced that they would be prepared to support the disbursement of a substantial portion of that package—about US$8 billion—contingent on a voluntary program by bank creditors to extend the maturities of existing claims on Korea.
In New York, roles were assigned to bring some order to the roll over process. Chase Manhattan Bank was to coordinate smaller banks in the U.S.; J.P. Morgan & Co. was to work on a plan for the second stage—restructuring debt falling due beyond the first quarter of 1998 and raising new money; and Citibank was to work with non-U.S. banks.
In working with non-U.S. banks, William Rhodes, Vice Chairman of Citibank, was instrumental. One of his major tasks was to work with Japanese banks, the group that had the largest exposure to Korea and yet was among the slowest to coordinate their own response. At that time, the Japanese banks were having their own funding problems. Their domestic bad debts were growing and their capital was being eroded with the fall of the Nikkei. After meeting with heads of top ten banks and Eisuke Sakakibara, Japanese Vice Minister of Finance, Rhodes finally was able to convince the Japanese banks to roll over lines falling due at the year-end until at least January 5.
On December 29, major creditors gathered at J.P. Morgan and confirmed they would roll over their credit falling due by the end of 1997, though for varying periods. This temporary extension provided a valuable window for the creditors and the Korean government, on behalf of the debtors, to engage in a debt restructuring negotiation. The IMF also accelerated its disbursement to Korea: instead of waiting until the next scheduled disbursement date (January 8, 1998), the IMF Executive Board approved a US$2 billion disbursement on December 30, 1997.
Government Appoints Legal Advisor for Debt Restructuring
In Seoul, on December 28, 1997, Cleary, Gottlieb, Steen & Hamilton (hereafter Cleary) informally showed interest in becoming a legal advisor to the government to help the banks in rolling over short-term debt. Initially, the law firm was approached by the creditors and was asked to be their legal advisor. However, as the law firm was already advising the government on the issuance of the government’s sovereign bond, Cleary wanted to be on the debtor’s side instead of the creditors’. The government responded positively and appointed Mark Walker and Robert Davis of Cleary to be the legal advisors.2
J.P. Morgan Takes an Initiative
At the December 29 creditor meeting, J.P. Morgan & Co. unveiled its plan for a longer-term solution to Korea’s liquidity crisis. A document titled “Korean Financing Proposal: Indicative Terms and Conditions” described the proposal in detail. The proposal basically called for (i) the exchange of part of the short-term debt of Korean banks falling due during 1998 for government issued bonds (the exchange offer), and (ii) the issuance of additional government bonds for new cash (the new cash offer).
The package had two distinctive features. One was to make the exchange and the new cash offer simultaneously, which was not in accord with the government’s original intention. The package also prevented additional new offerings for a certain period of time. The second feature was to set the interest rate via a modified Dutch auction in which new cash and exchange offer participants would be requested to submit the interest rates at which they would be willing to accept the securities. The bids would be accepted starting from those with the lowest interest rates. The interest rate of the last bid that fills the target amount would then be applied to all the accepted bids. The same interest rate would be applied to both offers. The aim of this market-based pricing mechanism was to encourage as much voluntary participation as possible from the creditors.
J.P. Morgan’s Proposal Reaches the Government
The government, which was not present at the December 29 meeting in New York, received J.P. Morgan’s proposal on December 30 (Seoul time). The proposal immediately raised a number of concerns to the government. First, the simultaneous offering seemed to have a lower chance of a success in raising new cash in comparison with a sequential offering that would extend the maturity of existing loans first and then issue a sovereign bond for new cash. The latter strategy obviously gave more time to prepare a bond issue, and the bond could be issued in more favorable circumstances after the debt maturity had been extended.
Second, pricing via a modified Dutch auction was likely to result in a higher interest burden for a number of reasons. According to such mechanism, the debtor does not have any voice in determining the interest rate, naturally leading to a high interest rate. Moreover, it would not be the average interest rate of the accepted bids, but the interest rate of the last bid that fills the target amount that would be applied to the offering. According to this scheme, creditors do not know how much of the original loans would be replaced by Korean government debt before the bidding. Such uncertainty would also induce investors tendering for the new cash offer to bid a higher price than they would if the question of existing loans was already resolved.
Third, replacing bank debt with government debt had the risk of terminating the close working relationship domestic banks previously enjoyed with their foreign counterparts. In fact, several Korean branches of international banks had expressed their preference for a government guarantee to a complete replacement by government bonds.
Lastly, there was a technical problem with J.P. Morgan’s proposal. While government only had a US$10 billion approval from the National Assembly to issue a sovereign bond, J.P. Morgan’s proposal required a much larger bond issue.
Government Seeks Outside Advice
Before finalizing its position on J.P. Morgan’s proposal, the Korean government asked for advice from the two joint financial advisors—Goldman Sachs& Co. and Salomon Smith Barney—and from the IMF. A memorandum sent to the Ministry of Finance and Economy on January 2, 1998, best describes the position held by the two investment banks. In the memorandum, they were basically in favor of a sequential approach: restructuring the existing bank debt first and then attempting to issue a large sovereign bond. As for the exchange offer, they were concerned that a Dutch auction mechanism is a very public and a high profile transaction, which effectively eliminates any possibility for the government to re-negotiate the terms.
The stance taken by the IMF regarding J.P. Morgan’s proposal can be learned from the letter sent by Stanley Fischer, First Deputy Managing Director of the IMF, to the Ministry of Finance and Economy. In a letter dated January 4, Fischer took a neutral stance, advising the government not to reject any financing or restructuring proposal for the time being, and to quickly seek advice from a financial advisor who knows the market well and who has an objective view.
Ambassador Chung Visits the United States
Between January 4 and 6, 1998, In-Yong Chung, Korean Ambassador of International Finance, visited the U.S. and met with the IMF, major creditor banks in New York and their regulators, the U.S. Treasury, and the New York Federal Reserve Bank. The meetings were mainly for fact-finding. The following findings were noteworthy. First, Japanese banks were more in favor of debt maturity extension than of converting the existing debt into longer-maturity government bonds. Second, it was reconfirmed that countries participating in the supplemental financial support package would accelerate their disbursement only if the debt maturity was extended, making this an urgent matter. Third, major creditor banks and their supervisors were all expecting an official action on debt maturity extension by the government no later than the end of January. To the date of Ambassador Chung’s visit, debt rollover was discussed only among creditor banks without the presence of any Korean entity. Fourth, many creditors called for a neutral financial advisor to be appointed by the government. Fifth, many creditors emphasized the importance of having one voice from Korea after the presidential election.
Government Starts to Draft Its Own Proposal
Given all the criticism raised against J.P. Morgan’s proposal and fact-findings by Ambassador Chung, the government started to draft its own proposal on January 5, 1998. In a meeting held at the Deputy Prime Minister’s office on January 7, 1998, the Korean government came up with three principles regarding its own proposal. The first principle was to take a sequential approach and initially concentrate on extending the maturity of existing bank debts. The second was to use government guarantee as a way of extending the maturity. This was different from J.P. Morgan’s proposal, which suggested replacing existing loans with government issued bonds. The third was to set the interest rate via negotiation.
In that meeting, government also decided to send a working-level delegation to attend the meeting with creditor banks, scheduled to be held on January 8 in New York. The delegation’s tasks were to convey the message that the government would make its own proposal to the creditors by mid-January and to gather information on each creditor’s position regarding J.P. Morgan’s proposal.
Government Meets Major Creditors in New York
The meeting with creditor banks took place at Citibank’s New York headquarters. Ten banks, each representing a geographical region, and observers participated in the meeting. The Korean delegation was composed of Yangho Byeon (Director, International Finance Division, MOFE), Mark Walker and Robert Davis (legal advisors from Cleary, Gottlieb, Steen & Hamilton), and others. The meeting started with a telephone briefing by Stanley Fischer on the Korean economy. The key message of his briefing was that Korea would need foreign exchange amounting to US$44 billion during 1998, and that the situation called for close cooperation from the major creditors.
After Fischer’s briefing, Director Byeon explained the three principles the government had set out earlier on the financing/restructuring package and promised that the delegation would come back to New York with a more complete proposal in the week of January 19. Director Byeon also noted that the three principles were only initial thoughts and that the government would welcome any proposal from the creditors. There was no strong opposition from the creditors at the meeting.
During their stay in New York, the delegation found that Citibank and Chase Manhattan Bank were basically in accord with the government’s position. In particular, they found that Citibank was in favor of rolling over all existing loans up to late March.
Government Organizes a Unified Team for the New York Negotiation
On January 11, 1998, at a meeting between Yong-Hwan Kim, Co-Chairman of the Joint Presidential Committee on Economic Policies (hereafter JPC), and Chang-Yeul Lim, Deputy Prime Minister, the government decided to establish a special subcommittee and a working-level task force to prepare for negotiations with creditors in New York. Great care was taken to ensure that the subcommittee and the task force included individuals associated with President-Elect Dae-Jung Kim. This was to prevent any confusion from having multiple voices speaking for Korea. President-Elect Dae-Jung Kim established the JPC immediately after his victory on December 18, 1997, to take charge of economic policy before his term started in February.
It was decided that the special subcommittee would be headed by Yong-Hwan Kim and be composed of the Deputy Prime Minister, the Governor of Bank of Korea, the Chief Secretary to the President on Economic Affairs, and one person to be appointed by the committee chairman. The subcommittee was empowered to make final decisions on the Korean proposal and compose the delegation to be sent to New York. It was decided that the working-level task force would be headed by Duck-Koo Chung, Deputy Minister for International Finance and Economy (hereafter Deputy Minister), and was to be staffed by JPC officials, Ministry officials, investment bankers from Goldman Sachs & Co. and Salomon Smith Barney, and Mr. Mark Walker. The task force was mandated to draft the Korean proposal and come up with detailed negotiation strategies.
Government Revisits the Basic Principles of the Proposal
At the same meeting on January 11, 1998, the government revisited the basic principles of its restructuring/financing proposal. First, the government again made clear that it would decline J.P. Morgan’s proposal. The proposal was regarded as serving only the interests of creditors, and risked aggravating the moral hazard problem among creditors. Creditors would not only have their non-performing loans to near-bankrupt Korean banks replaced by government bonds with a much higher market value, but they would also have the right to charge a high interest rate. According to the scheme, existing creditors would hardly pay a price for their misjudgment in lending to Korean banks.
Second, on sequencing, the government decided to begin with a debt maturity extension. A syndicated loan would follow immediately after that in February, if possible, and a sovereign bond would be issued only in a favorable market situation. It was emphasized that existing creditors should be treated differently from new creditors that would participate in the bond issuance: the former had made a misjudgment and consequently should pay some penalty on rolling over existing obligations into new bonds or loans; the latter were starting fresh. So, to be fair, the former should receive a lower interest rate than the latter. J.P. Morgan’s proposal, however, did not make this distinction and allowed existing creditors to charge the same interest rate as the new ones.
Third, the government made a number of decisions on the details of the debt maturity extension. Only the short-term debt of banks coming due in 1998 would be eligible for extension. Long-term debts, merchant bank debts, bonds, off-balance sheet items, overnights, and trade financings would be excluded. Long-term debt falling due in 1998 was relatively small amounting to US$ 10.7 billion. A joint investigation conducted in early January with the IMF and the Federal Reserve Bank of New York revealed that the size of off-balance sheet items was relatively modest and that the maturity structure was well matched. Overnight loans were excluded because their maturity by nature could not be extended to one or more years. Trade financing was excluded because it was a safe credit in the first place with its underlying physical transaction and by nature could not be extended to one or more years.
Since the economic situation was improving, the maturity would be extended only up to five years, preferably under three years. The interest rate would be determined by negotiation between the two parties. Instead of issuing a government bond or the government taking a loan, as a way to extend the maturity, Korean banks would receive government guaranteed bank loans from the creditors, although voluntary extensions without government guarantee would be encouraged.
Government Lays Out a Negotiation Strategy
During January 13 and 14, 1998, at meetings between Yong-Hwan Kim and Chang-Yeul Lim, the government discussed its strategies and tactics for the negotiation in New York. Three points were noteworthy.
First, the government decided to have individual meetings with the core banks and their supervisors before the negotiation started on January 21. The goal was not only to persuade them to accept the government’s proposal, but also to update the government’s proposal after having identified the position of each bank. In-Yong Chung was to visit Europe (January 13-15) and Woo-Suk Kim, Director-General of International Finance at the Ministry, was to visit Japan (January 15-16). It was important to soothe the feelings of Japanese and European banks that felt they had been excluded from the recent talks despite the fact that they had more exposure to Korean banks than did the U.S. banks.
As for the U.S. banks and their supervisors, Yong-Hwan Kim and Jong-Keun You, the President-Elect’s Economic Advisor, were to visit Washington D.C. and New York immediately before the negotiation on January 18-19. They were to meet key U.S. banks, the Treasury Department, the Federal Reserve Board, and the IMF. These meetings were to be held confidentially so as not to provoke any annoyance from the banks that were not contacted. Mark Walker was also to meet banks in the U.S., Japan (January 10-14), and Europe (January 15-18).
The second point was in regard to how the negotiation meetings should be organized. Mark Walker advised the government to ask William Rhodes, Vice Chairman of Citibank, who Walker had previously worked with, to preside over the meeting at Citibank, and suggested which bank representatives to invite. Stanley Fischer, First Deputy Managing Director of the IMF, would be asked to attend the meeting; Michel Camdessus, Managing Director of the IMF, would be asked to participate by phone; and William McDonough, President of the New York Federal Reserve Bank, would be asked to deliver a speech. Yong-Hwan Kim would deliver a speech on the Korean economy and Duck-Koo Chung would outline the Korean proposal. It was intended to make sure that the discussion centered on the Korean proposal rather than on J.P. Morgan’s.
The third point was to organize a team of Korean bankers to assist the negotiation team on interest rate matters. Bankers from the Korea Development Bank and the Korea Exchange Bank were to be recruited to form a back-up team to provide relevant data and analysis during the New York negotiations.
A moratorium as a negotiation strategy was considered but rejected without much disagreement. It was expected that existing debt could be rescheduled with a very low interest rate if Korea announced a moratorium. The government, however, had to consider the side effects. Korean firms were expected to suffer greatly in overseas transactions with a government moratorium. They would not only have a hard time financing capital from abroad but also would be forced to settle payments in cash. This would greatly constrain imports of raw materials necessary for Korea to survive and to export out from the coming recession.
Government’s Foreign Exchange Cash Flow Projections
In preparation for the negotiation meeting, the government updated the foreign exchange cash flow projections for 1998 (Table 1). The financing gap was estimated to be US$29.8 billion. Out of US$68.2 billion of total foreign exchange needs, short-term debt falling due to financial institutions was estimated to be US$25 billion. The rest came from long-term debt, commercial paper, and foreign exchange needed to reinforce official reserves. Out of US$38.4 billion of total financing, borrowing under the IMF program was estimated to be US$24.7 billion. The rest came from a projected current account surplus, foreign investment, and corporate sector borrowing. The financing gap of US$29.8 billion was to be addressed by short-term debt maturity extension (US$15 billion) plus new money from syndicated loans (US$5 billion) and a sovereign bond issue (US$10 billion).
|Foreign Exchange Needs||68.2|
|Reinforcing FX Reserve||31.8|
|Foreign Exchange Funding||38.4|
|Disbursement from IMF||24.7|
|Current Account Surplus||3.2|
|Net Borrowing by the Corporate Sector||3.5|
Reactions from Europe and Japan
The visits by In-Yong Chung, Woo-Suk Kim, and Mark Walker to Europe and Japan revealed that banks in those regions were more in favor of the Korean proposal than of J.P. Morgan’s. Part of the reason came from their resentment toward U.S. banks, which they thought were monopolizing the discussions. This meant the creditors were starting to fracture, while the Koreans were showing unity.
Another reason was that the European and Japanese banks were commercial banks that put more value on preserving traditional business relationships with Korean banks than did J.P. Morgan, which was acting more like an investment bank. In particular, they criticized J.P. Morgan’s proposal of a 20-year government bond with no call option, which would require the government to pay high interest rates for too long. They opposed the modified Dutch auction mechanism for fear that rates might come out so high that there would be a political backlash in Korea against the whole deal. With these visits, the government was able to correct the perception of Japanese and European banks that Korea tended to talk only with the U.S. creditors.
On January 16, 1998, major creditors officially completed a plan to roll over short-term loans to Korean banks through March 31. This gave creditor banks and the government time to sit down and work out a long-term agreement in the following week. A fax message from Citibank Vice Chairman William Rhodes informed the government that Citibank had received confirmation from all regional coordinating banks that the banks in their constituencies supported the program to roll over short-term maturities to Korean financial institutions through March 31. The fax noted that David Pflug, Vice Chairman of Chase Manhattan Bank acting as regional coordinator for the U.S. banks, had advised that all of the U.S. banks were participating.
Delegation and the Official Directive
On January 17, 1998, President Young-Sam Kim approved the Korean delegation and the official directive given to them. Given the technical nature of the negotiation, the delegation was divided into high-level and working-level groups. The first group, headed by Yong-Hwan Kim, was to meet with core U.S. banks and their supervisors outside the negotiation table. The second group, headed by Deputy Minister Duck-Koo Chung, was to lead the actual negotiation.
The directive included all the major principles discussed earlier. Three new items were noteworthy. First, it allowed the creditor banks to shift their loans from weaker to stronger banks. Second, it allowed the debt to be denominated in major currencies other than the U.S. dollar. Third, the directive included the option of prepayment of debt. In case the delegation could not abide by the directive, it had to ask for a revised version from the Deputy Prime Minister, who would be staying in Seoul during the negotiations. As for matters not specified in the directive, the delegation had discretion to make its own decision. Given the technical nature of the negotiations, Mark Walker took charge of preparing the term sheets. Also, to minimize any mistake from the delegation, it was decided to go through Mark Walker when communicating negotiation terms with the creditor banks.
The New York Negotiation
Day One: January 18
Part of the Korean delegation, including Yong-Hwan Kim, Jong-Keun Yoo, In-Yong Chung, and Duck-Koo Chung, arrived in New York. In the afternoon, they discussed a Lehman Brothers proposal that the government set up a paper company to purchase short-term loans from creditor banks and issue securities backed by these loans. The paper company was to be capitalized by government bonds, gold, or cash. The size of the capital was estimated to be 25-30 percent of the debt to be purchased. The proposal, however, was rejected on the basis that it did not necessarily help in extending the maturity of existing debts.
Day Two: January 19
The Korean delegation had individual meetings with major U.S. financial institutions: Jon Corzine, Chairman of Goldman Sachs; D. Maughan, Chairman of Salomon Smith Barney; Douglas Warner III, Chairman of J.P. Morgan; and William Rhodes, Vice Chairman of Citibank. As expected, Corzine, Maughan, and Rhodes were quite supportive of the government, while Warner was not.
In the morning meeting with Goldman Sachs, Jon Corzine supported the government’s strategy of separating the exchange offer from the new cash offer. He expected that a successful negotiation in extending debt maturity would trigger rating agencies to place Korea at a higher credit rating. Referring to the New York Times article on January 17 by Thomas Friedman, he mentioned that the U.S. Congress was concerned that creditor banks might be completely bailed out from the crisis. He mentioned that this concern, together with the move on January 16 by Standard & Poor’s to change the rating outlook from “negative” to “developing,” would work in favor of the government at the negotiation table. He also thought that the President-Elect’s direct dialogue with the public that was televised live on national networks on January 18 had contributed to improve foreign investor confidence.
Chairman Maughan of Salomon Smith Barney basically said the international capital market was not ready for a bond issue worth US$25 billion and that it would be wise to postpone the bond issuance until credit ratings had improved. He also expected that a successful debt maturity extension would trigger Standard & Poor’s to raise the Korean credit rating three steps from B+ to BB+. Moreover, a successful debt maturity extension would flatten the currently inverted yield curve, which, in turn, would permit the government to later issue a sovereign bond with a shorter maturity of three to five years. In terms of the government’s leverage at the negotiation table, Chairman Maughan mentioned four points. First, the government guarantee had reduced credit risk. Second, the yield curve was flattening. Third, the Basel Accord on capital adequacy allowed creditor banks to free capital once an OECD sovereign guarantees the debt. Fourth, in the long run, creditor banks can make profits by keeping the relationship with Korean banks. He even told the Korean delegation that a rate of LIBOR+200-250 basis points would be possible for the extended debt.
At the meeting with J.P. Morgan in the afternoon, the delegation confirmed that J.P. Morgan was not in favor of the government’s proposal. Chairman Warner stressed that a comprehensive approach of carrying out exchange and new cash offers simultaneously is more appropriate at a time when Korea urgently needs foreign exchange. Although he showed some flexibility regarding the determination of interest rate by giving up the modified Dutch auction J.P. Morgan had originally proposed, he emphasized the need for any debt maturity extension to be voluntary. He also mentioned the need for off-balance sheet items to be included in the debt eligible for government-guaranteed extension. In response, the delegation made clear that off-balance sheet items would not be included in eligible debt.
The rest of the delegation arrived on January 19. At the law office of Cleary, the negotiation team headed by Duck-Koo Chung prepared for the meeting on January 21. The Cleary office became the base camp of the delegation throughout the negotiation.
Day Three: January 20
Part of the delegation headed by Yong-Hwan Kim visited Washington D.C. and met with major opinion leaders: Alan Greenspan, Federal Reserve Chairman; Joseph Stiglitz, World Bank Chief Economist; Fred Bergsten, Institute for International Economics Director; Robert Rubin, Treasury Secretary; Stanley Fischer, IMF First Deputy Managing Director; and Charles Dallara, Institute of International Finance Managing Director.
In the morning meeting, Alan Greenspan thought that the Korean economy would recover as long as the government accelerated its structure reforms, particularly those leading to a reduction of corporate debt. On debt maturity extension, however, he recommended that the negotiations should be completed as soon as possible even if that meant somewhat unfavorable interest rate terms. In the following meeting, Joseph Stiglitz expressed concern that the IMF program would bring a credit crunch, and suggested that the government make sure trade financing was not curtailed. He told the delegation that the United States also experienced a credit crunch in the early 1990s despite the successful resolution of the S&L crisis in the late 1980s.
Fred Bergsten hosted a luncheon. Referring to the atmosphere at the U.S. Congress, he stressed that creditor banks needed to take a haircut as a way of assuming part of the responsibility. He was also interested in what effect the depreciated currency would have on exports. In the afternoon meeting, Treasury Secretary Robert Rubin suggested that the government take a comprehensive approach by making exchange and new cash offers simultaneously. He was also concerned with Korean banks’ off-balance sheet obligations. In the following meeting, Stanley Fischer suggested that the government limit the amount of debt that could be converted to a one-year loan.
At the cleary office in New York, the rest of the delegation made final preparations for the next day’s meeting. Final touches were made on the term sheet, the presentation slides, and the speech.
Day Four: January 21
In Seoul, the National Assembly approved a bill submitted by the government to guarantee foreign currency debt of US$15 billion plus interest. While the National Assembly had passed a similar bill in December 1997, amounting US$20 billion plus interest, it did not cover debt that the Bank of Korea would incur from the countries participating in the supplemental financial support package, and thus was not enough to cover all the debt eligible for maturity extension. Out of a total of US$15 billion, US$8 billion was intended to guarantee the Bank of Korea’s debt and US$7 billion was to guarantee maturity extended debt of commercial banks, state-owned banks, and merchant banks not covered by the previous bill. The bill was passed on the condition that the government guarantee would be extended only to viable financial institutions.
On the same day in New York, the delegation had additional meetings with the banking community before the official negotiation started in the afternoon. A breakfast meeting was arranged with New York Fed President, William McDonough. During the meeting, he fully acknowledged the government’s position, but also emphasized that it was in Korea’s interest to expedite the negotiation since the situation in Indonesia was worsening. He stressed that it would be inappropriate for the government to guarantee off-balance sheet obligations, and agreed that creditor banks should refrain from asking for high interest rates on the grounds that it would only aggravate moral hazard. During a meeting with Chase Manhattan Chairman Shipley, he emphasized that the interest rate should be determined on a voluntary basis through a market-based solution, indicating that Korean banks might have to pay a high interest rate.
The first negotiation meeting with creditors took place between 2:00 and 4:30 p.m. in the second floor boardroom at Citibank’s Park Avenue headquarter in New York. Yong-Hwan Kim headed the Korean negotiation team. Fourteen creditor banks from eleven countries participated the meeting. Terrence J. Checki, Executive Vice President at the New York Federal Reserve Bank, also attended. Duck-Koo Chung presented foreign exchange projections for 1998 and the government’s proposal to address the financing gap; Mark Walker, legal advisor, made additional explanations as to the details of the government’s proposal. Stanley Fischer briefed the banks by telephone. The Korean delegation proposed a list of ten creditor banks to represent all the creditors and negotiate on their behalf. The ten banks were chosen on the basis of their credit exposure and geographical representation.
Thanks to the government’s marketing effort before the meeting and the resentment from European and Japanese banks toward the U.S. banks, the overall mood was favorable toward the delegation and the discussions centered on the government’s proposal instead of J.P. Morgan’s. Although J.P. Morgan continued to push its plan arguing that the Dutch auction was the best method for price discovery, the argument did not last long. Morgan had limited leverage, and could not refuse to do the rollover just because the Koreans would not raise new money through the Dutch auction.
Among the items discussed during the meeting, three points in particular were noteworthy. First, creditor banks raised the concern that if the debt maturity was to be extended, the participating banks would exhaust all their exposure to Korean banks and this would make it difficult for any new business to take place with the Korean banks. To this, the delegation made clear that the extended loans would be transferable. Also, they emphasized that a successful debt maturity extension would significantly ease the foreign exchange liquidity problem and would reduce credit risk toward Korean banks, which, in turn, would allow a greater exposure to them. Second, creditor banks asked if loans to merchant banks were also to be eligible for a guarantee and maturity extension. To this, the delegation replied that the government guarantee would apply only to those merchant banks that are financially viable. Since investigation on the viability of merchant banks was still in process, the delegation was not able to name which merchant banks would be eligible obligors. Third, some creditor banks were concerned that a sovereign bond issuance later, at a lower rate, would discount the value of loans extended earlier. To this, the delegation argued the opposite: a concurrent new cash offer would allow existing debt to be extended only at a high interest rate.
It was agreed that the creditor banks would come up with a list of 10-15 banks that would represent all creditors based on the list suggested by the Korean delegation. The next meeting was scheduled on January 23 to discuss the details of the debt maturity extension. Creditor banks needed some time to consult with the banks in their constituencies. A one-page press release stated that the discussions were very positive and constructive.
Day Five: January 22
The negotiation team led by Duck-Koo Chung discussed strategies for the meeting next day. Yong-Hwan Kim and Jong-Keun Yoo flew back to Washington D.C. to meet with Michel Camdessus.
During the strategy meeting in New York, four issues were discussed. First, for the time being, it was decided that merchant banks were to be excluded from the eligible obligors. Second, it was decided to cap the one-year extension within 20-25 percent of the total obligation being extended. It was not certain that the Korean economy would normalize within a year and it was not wise to let debt obligations be concentrated in a particular year. Third, the team decided to consult experts at Bears Stern, which did not have any exposure to Korea, on the interest rate. Experts from the Korea Development Bank and the Korea Exchange Bank suggested a spread of LIBOR+150-190 basis points as a starting point at the negotiations. This spread was obtained by surveying the rates applied to loans to a sovereign with a comparable credit rating. Fourth, the delegation requested Citibank to include more banks from Japan and Germany to represent the creditors, while excluding ING Bank, which was more like an investment bank. Japanese and German banks were perceived to be more favorable to the government’s proposal. The request was accepted and Citibank included Sanwa Bank and West Deutsche Landesbank, while excluding ING Bank. Deputy Prime Minister Chang-Yeul Lim subsequently approved these decisions by telephone.
Day Six: January 23
The second meeting with creditors took place between 2:00 pm and 6:00 pm. Deputy Minister Duck-Koo Chung headed the Korean negotiation team. Thirteen banks from seven countries attended the meeting as official representatives. Terrance Checki, Executive Vice President of the New York Federal Reserve Bank, also attended as an observer.
The discussions centered on the following five issues. First, creditor banks were suspicious that the real debt figures falling due in 1998 for Korean merchant banks was much higher than what was reported by the Korean delegation. They also noted that it was likely that British banks would not participate in the maturity extension agreement if merchant bank debts were not included in the eligible debt. To this, the delegation suggested that this matter should be taken up separately after the viability investigation was completed on the merchant banks.
Second, creditor banks questioned whether it was guaranteed that all Korean banks would accept any agreement reached in New York. They warned that Korean banks’ full participation was critical for the success of the maturity extension. To this, the delegation promised to immediately re-confirm with the Korean banks as to their acceptance and inform the creditor banks at the next meeting (January 26).
Third, creditor banks raised the interest rate issue for the first time and suggested the IMF’s Supplemental Reserve Facility rate of LIBOR+ 350 basis points as the basis of discussion, noting that the current yield on bonds issued by the Korea Development Bank, which then prevailed at LIBOR+585 basis points. They also tried to leverage the worsening Indonesian situation to get concessions from the delegation regarding the interest rate. The Korean delegation responded that it would bring its own interest rate proposal to the next meeting.
Fourth, to enhance tradability, the creditor banks suggested to exchange existing floating rate note (FRN) loans for transferable loan certificates (TLC). They also argued that the prepayment option should be restricted so as not to limit the tradability of the claims. Specifically, they suggested that there should be no option for one-year maturity claims and to allow the option for longer maturities only after a certain period had lapsed, say one year for two to threeyear maturity claims and two years for five-year maturity claims. The delegation refused the exchange of FRN loans on the basis that it would be difficult to maintain existing business relationships between the Korean banks and the international banks.
Fifth, the creditor banks suggested that loans be denominated either in U.S. dollars or in Japanese yen. Japanese banks said that they expected more than half of the existing exposure would be denominated in yen once existing loans were replaced by longer-maturity loans. The next meeting was scheduled for January 26.
Days Seven and Eight: January 24 and 25
During the weekend, the negotiation team gathered at the Cleary office and reviewed the issues raised at the meeting of January 23. On the merchant bank issue, the delegation decided, with approval from the Deputy Prime Minister, to allow merchant banks’ existing debt be eligible for maturity extension for those merchant banks judged viable by the government by March 31, 1998.
Given that many merchant banks had foreign owners, the delegation decided to exclude from eligible debt the obligations owed to certain foreign banks that had 20 percent or more of the capital of an eligible obligor or had influence over the eligible obligor’s management. On the tenor issue, the delegation decided to limit the one-year offerings within 20 percent of the total offering, so as not to have obligations concentrated too much in the following year. They also decided to limit the size of the five-year offerings to US$5 billion, so as not to be locked in with high interest rates for a large amount of debt.
On the currency denomination issue, the delegation decided to allow yendenomination, provided that the eligible debt was originally yen denominated. On the tradability issue, the delegation decided to refuse the issuance of FRN, but to allow creditor banks to change the debtor bank on the first interest payment date, provided that it be informed no less than 90 days before, and that both the existing debtor and the replacing debtor consent to the trade.
On the interest rate issue, the delegation consulted with Bears Sterns and the Korean bankers that accompanied the delegation. They decided to propose a semiannual rate equal to six-month LIBOR plus a spread of 140, 155, 170, and 180 basis points, respectively, for a medium-term loan of one, two, three, and five-year maturity.
The following five principles were developed to back up the proposal. First, applicable margins had to reflect loan spreads available at that time to borrowers with comparable credit ratings. At that time, spreads applicable to syndicated loans to institutions with credit ratings comparable to Korea’s (Moody’s Bal; S&P B+) ranged from 62.5 (five-year maturities) to 197.5 basis points (six-year maturities). Thus the proposed applicable margin of 180 basis points for a medium-term loan with a 5-year maturity was a relatively high spread. A few days before, S&P had upgraded its credit rating outlook with respect to Korea from “negative” to “developing,” which further suggested that the proposed applicable margins were not unreasonable or unrealistic.
Second, prevailing bond yields were not an appropriate benchmark for the applicable margin since there are fundamental differences between the banklending market and the debt capital market. Pricing in the bank loan context take into account long-term business relationships, which do not exist in the public bond markets. In addition, bond spreads are intended to compensate for the relatively higher volatility in the debt capital markets. Two recent examples of disparities between sovereign bond yields and loan interest rates were provided.
Third, prevailing spreads on bank loans obtained by Korean banks were not an appropriate benchmark for the applicable margins since participation in the proposed exchange program would provide existing creditor banks with significant benefits. First of all, the creditor banks would benefit from reduced default risk, due to Korea’s guarantee of the medium-term loans. Next, the creditor banks would benefit from increased BIS capital ratios. Lastly, the creditor banks would benefit from reduced country default risk, due to the coordinated extension of maturities of short-term bank debt under the exchange program.
Fourth, spreads applicable to the Supplemental Reserve Facility (SRF) provided to Korea by the IMF were not an appropriate benchmark for the applicable margins. The emergency funds provided by the 13 countries, as well as the SRF, carried relatively high interest rates. However, such rates were deliberately fixed at a high level for policy reasons. As explained by Mr. Geithner, the U.S. Assistant Treasury Secretary, “The IMF is providing loans at substantial premiums to maximize assistance, minimize use, and ensure quick repayment.”
Fifth, high applicable margins were undesirable in light of the moral hazard problem, and also damaging for political reasons. Without a haircut, creditors risk falling into the habit of blind lending. Also, if the applicable margins were set at an excessively high level, emergency funds provided by the thirteen countries might be channeled to service the medium-term loans. There was a risk that such channeling of public funds for private profit would create a negative public perception of the exchange program and result in a political backlash in the thirteen countries.
As a negotiation strategy the delegation decided to discuss the pricing issue only after a certain degree of agreement had been reached on all other matters. This separation was intended to prevent the creditor banks from linking other matters with the pricing issue. Deputy Prime Minister, Chang-Yeul Lim, confirmed that the Korean bankers would fully participate in any agreement that would be reached between the creditor banks and the government delegation.
Day Nine: January 26
Prior to the third meeting with the entire creditor bank representatives the delegation met with J.P. Morgan, Citibank, Tokyo-Mitsubishi Bank, Société Générate, and Commerzbank. A significant gap still seemed to exist between the delegation and the creditors regarding the pricing issue. Vice Chairman Stern of J.P. Morgan regarded the SRF rate as a benchmark and suggested a spread of LIBOR+300-450 basis points. In the following meeting, Vice Chairman Rhodes of Citibank was concerned about Jong-Keun Yoo’s interview with the Wall Street Journal, where he stressed that creditor banks should also take a haircut. Japanese and European banks emphasized that the spreads should be set at a level acceptable to the market participants.
The negotiation meeting with the creditor bank representatives took place at Shearman & Sterling, a law firm advising the creditors, from 11:00 a.m. to 5:00 p.m. The meeting started with a short speech from Duck-Koo Chung, who clarified the Korean government’s position on issues other than pricing. Mark Walker then presented the revised term sheet, which was discussed after lunch.
On the merchant bank issue, creditor banks, the British and German banks in particular, strongly argued that merchant banks should not be treated differently from other banks. They questioned why only merchant banks, but not commercial or state-owned banks, had to go through the government’s viability assessment. They also noted that creditor banks did not discriminate merchant banks from commercial banks when they extended debt maturity until the end of March, and argued that the government should abide by its August 25, 1997 announcement to guarantee all debt incurred by Korean financial institutions, including merchant banks.
On the prepayment issue, the delegation explained that restricting the exercise of option during the first year, the government intended to limit banks from refinancing high-cost medium-term loans with low-cost short-term loans, which would increase the fraction of short-term loans. On FRN, some banks continued to request it even after it was clear that they would have more enhanced tradability by having the option to change debtor banks.
The rest of the afternoon session mainly concentrated on the pricing issue. After short comments by the Deputy Minister, Mark Walker detailed the pricing proposal and the rationale behind it. After an hour of discussion among themselves, the creditor banks came back and told the delegation that the proposed spreads were unrealistic and that the delegation should reconsider its proposal. The meeting ended with a decision to meet the following day.
After the meeting with creditors, the delegation members gathered at the Intercontinental Hotel and further discussed their strategies regarding the pricing issue. It was expected that the creditor banks would make a counterproposal. In this case, it was decided that the delegation request a one-hour recess and suggest a revised proposal with spreads higher by 30-40 basis points. With rounds of counterproposals, it was expected that the gap would narrow and agreement be reached. The SRF rate of LIBOR+350 basis points was set as the reservation rate.
Day Ten: January 27
At 5:30 a.m. the delegation received news that Indonesia had temporarily ceased to service its debt. Although Indonesia insisted that it had not declared a moratorium, many believed that a moratorium was already in effect, given that many companies had ceased servicing their debts. This made it urgent to conclude the pricing negotiation as soon as possible.
The fourth meeting with creditor bank representatives took place at Shearman & Sterling and lasted more than seven hours. Mark Walker started by going through the Korean proposal again, stressing that creditor banks must take into account the fact that loans were being guaranteed by the government, and that pricing proposals should be backed by market data. In response, the creditor banks requested a recess and after 40 minutes of discussion, came up with their first counter proposal of spreads of 275, 325, 350, and 380 basis points, respectively, for one, two, three, and five-year maturity loans. These spreads were 135-200 basis points higher than the Korean proposal.
In return, the delegation requested a recess and made a revised proposal with spreads of 175, 190, 200, and 215 basis points, which were 100-165 basis points lower than the spreads proposed by the creditors. European banks argued that they would be unable to continue the negotiation based on the low interest rates proposed by the Korean delegation, which would require them to increase loan-loss provisioning. The creditors also reminded the delegation that the deal had to be sold not just to the banks in the negotiation room, most with long-term commitments to Korea, but also to over 200 other lenders around the world, some with little at stake in Korea other than getting their money back.
In the afternoon session, the creditor banks came up with their second proposal. They suggested excluding the five-year maturity loan from the negotiation, incorporating the delegation’s argument that the spread on the five-year maturity loan was too high. They lowered the spreads and proposed 275, 300, and 325 basis points, respectively, for one, two, and three-year maturity loans. The delegation asked for a recess and discussed whether it would make another proposal or accept the offer. A number of factors pointed toward accepting the proposal. Most of all, the spreads proposed by the creditors were below the reservation rate of LIBOR+350 basis points. Also, the worsening situation in Indonesia mandated an early conclusion. Lastly, it seemed that the creditor banks had no room to concede any further. Despite these considerations, the delegation decided to make one last proposal. They proposed 185, 200, and 220 basis points, respectively, for one, two, and three-year maturity loans. To this, the creditor banks responded that agreement could not be reached, and suggested another meeting the following day.
Since it was likely that agreement would be reached next day, the delegation prepared for a press release after the meeting. The term sheet was revised to exclude a five-year maturity extension. The delegation was told to consult with the Deputy Prime Minister before they committed to a final agreement with the creditors.
Day Eleven: January 28
The fifth meeting with creditor bank representatives took place at Shearman & Sterling at 10:00 a.m. The meeting started with negations on matters other than pricing. Most of the discussion took place between the lawyers for each side. No significant gap emerged between the delegation and the creditors. After a ten-minute break, the creditors made their third pricing proposal. They suggested 225, 250, and 275 basis points, respectively, for one, two, and three-year maturity loans. The figures were 50 basis points lower than the previous proposal across all three maturities. The gap from the delegation’s proposal was also only 40-55 basis points. They stressed that any lower spread will trigger loan-loss provisioning, which would preclude any further discussion.
During the recess, the delegation gathered at the Cleary office and discussed their next move. There was consensus that the creditor banks no longer had room to lower the spreads any further. So, it was decided to seek a more favorable deal in terms of prepayment rather than in terms of pricing. The Deputy Prime Minister approved the directive to accept the interest rate offer, but at the same time to request that prepayments be allowed after six months from the loan exchange date for the two and three-year maturity loans.
The meeting resumed at 7:00 pm and the Korean delegation accepted the pricing proposal made by the creditor banks. It was declared that an agreement had been reached and a joint press release was prepared. In the press release, Deputy Minister Chung said, “The plan agreed today will provide a stable source of funding to the Korean banks on commercial, market terms, and on a voluntary basis. As such, the achievement marks a critical step in the efforts of Korea to surmount its current liquidity crisis and to restore stability to the Korean banking sector. We look forward to a successful completion of the exchange offer with the participation of all creditor banks.” Vice Chairman Rhodes added, “Today’s agreement is a key step toward Korea’s goal of returning shortly to the international capital markets.”
The Term Sheet
The final term sheet was titled “Proposal with Regard to the External Debt of Korean Commercial, State-Owned, and Specialized Banks (Including Overseas Branches, Agencies, and Certain Foreign Banking Subsidiaries) and Certain Merchant Banks.” The term sheet consisted of three parts: (i) definitions, (ii) terms and conditions of new loans, and (iii) exchange procedures.
On definitions, eligible debt covered inter-bank deposit obligations and short-term loans, other than excluded debt, owed to foreign banks and financial institutions by eligible obligors and maturing during calendar year 1998. Excluded debt covered trade finance, publicly traded securities (including securities sold pursuant to Regulation S or Rule 144A), commercial paper, overnight deposits, call money, contingent obligations such as derivatives and guarantees, and obligations owed to controlling shareholders of eligible obligors. Repurchase obligations were included, provided that the Bank of Korea’s monetary stabilization bonds or other won-denominated securities of Korean governmental issuers backed them.
Eligible obligors included thirty-three Korean commercial banks, stateowned banks, and certain specialized banks including their foreign banking subsidiaries and their overseas branches and agencies, but excluding their nonbank subsidiaries. Eligible obligors also included merchant banks, but not their subsidiaries, provided that they had been determined by the government to be commercially sound and viable prior to the commencement of the exchange offer.
According to the final term sheet, new loans guaranteed by the government had the following terms and conditions. New loans could have final maturity of one, two, or three years from the exchange date at the election of the holder of eligible debt at the time of the tender for exchange. A holder of eligible debt was not able to elect to exchange more than 20 percent of the eligible debt tendered by it for new loans with a final maturity of one year. Interest on the new loans had to be paid semiannually and interest was to accrue from the exchange date. The semiannual rate was equal to six-month LIBOR plus applicable margin of 225, 250, and 275 basis points, respectively, for one, two, and three-year final maturities.
New loans had to be denominated in the U.S. dollar, except that eligible debt denominated in the Japanese yen or the deutsche mark on December 31, 1997, may, at the option of the holder, be exchanged for new loans denominated in those currencies. Each eligible obligor had the right to prepay its new loans having final maturities of two or three years in whole or in part on any interest payment date, beginning with the first semiannual interest payment date, without premium or penalty.
In the event of the acquisition of an eligible obligor by another bank, the new loans of the acquired eligible obligor had to become obligations of the successor bank. In the event of a liquidation of an eligible obligor, its new loans would have to be assumed by the government or by another eligible obligor that agreed to such assumption. New loans were to be in the form of transferable loan certificates, in minimum denominations of US$250,000, transferable to other banks and financial institutions. The governing law for the new loan was the law of the state of New York.
On exchange procedures, the eligible obligors and the government had to invite holders of eligible debt to exchange their eligible debt for new loans of the same eligible obligor. On the first interest payment date for any new loan, the holder had the right to exchange such loan for a new loan of the same tenor and principal amount to a different eligible obligor designated by such holder not less than 90 days prior to such first interest payment date, with the consent of both the existing eligible obligors and the proposed substitute eligible obligor. No restriction was imposed on the transferability of eligible debt prior to the end of the exchange period.
New loans issued in exchange for each item of eligible debt had to have a principal amount equal to the principal amount of such eligible debt. Interest accrued and unpaid on eligible debt through the effective date had to be paid on the effective date. Each creditor tendering eligible debt had to agree to roll over until the exchange date of all eligible debt tendered. Each tendering creditor had to specify the final maturity and currency of the new loans that it wishes to receive in exchange for its tendered eligible debt. All tenders were considered irrevocable unless the Korean government amended the terms of the exchange offer in any material respect.
Since the Korean government’s objective was that substantially all eligible debt be exchanged for new loans in order to alleviate the liquidity shortage, the consummation of the exchange offer was subject to the receipt by the eligible obligors of tenders to exchange not less than US$20 billion of eligible debt. The exchange period was two weeks from the date on which the exchange offer is made, subject to extension for up to an additional two weeks at the election of the government.
Day Twelve: January 29
The delegation had a working-level discussion at Shearman & Sterling’s office on the details of the debt exchange with thirteen creditor banks and the two legal advisors. A schedule was tentatively agreed upon: three weeks were given to finish various documentations; the exchange offer was to be sent to the creditors on February 23, and two weeks were given for them to tender the offer; four weeks were allocated for reconciliation; and finally, debts were to be exchanged for new loans on April 7. The whole process would be finished in approximately two months.
To facilitate the exchange process, the Korean government needed to identify eligible debt as soon as possible. To this end, the government also agreed to identify the list of eligible debt holders, the list of subsidiaries and branches of obligors, and the finalized list of merchant banks eligible for debt exchange. It was also agreed to appoint various agents necessary for the debt exchange. As for the exchange agent, Citibank showed strong interest, and given Vice Chairman Rhodes’ leadership in the international banking community, no objection was raised to Citibank’s appointment.
The Debt Management Team3
Establishment of the Debt Management Team
To implement the debt exchange, a task force—the Debt Management Team for Korean Financial Institutions (hereafter DMT)—was established on February 9, 1998. Se-Pyo Hong, Chairman and President of the Korea Exchange Bank (hereafter KEB), headed the DMT, for KEB had the largest eligible debt among the obligors.
The DMT had to manage the whole debt exchange process. The most urgent task was to identify eligible debt by various categories (by obligor, by debt holder, by country, and by debt category). To this end, it had to obtain a list of contact points in all the debt holding institutions, identify numerous subsidiaries and branches of the obligors, and monitor new borrowings and repayments by obligors. During the exchange period, creditors’ participation rates were identified on a daily basis. The DMT also had to:
Appoint various agents including reconciliation, calculation, and syndicate agents;
Review documents by the legal advisors;
Conduct a series of road shows during the exchange period to maximize the amount of tenders;
Administer the issuance of a government guarantee to the obligors; and
Decide how to share the administrative costs among the obligors.
To effectively disseminate information regarding the debt exchange, the DMT issued a newsletter five days a week between February 18 and March 13. The newsletter was distributed via fax to all obligors, to relevant government ministries, and to supervisory institutions.
From February 27 to March 8, government and obligor banks conducted a series of road shows covering almost all the headquarter cities of creditor banks. During the presentations, government delegations noticed that perception on the Korean economy was improving. Moreover, they discovered that most of the creditor banks were favorable toward the exchange offer. Besides regular presentation meetings with creditor banks, individual meetings were also arranged with government ministries or central banks to ask for their cooperation in persuading creditor banks under their jurisdiction to roll over.
Changes to the January 28 Term Sheet
Since the term sheet agreed upon on January 28 was only a tentative agreement with a limited number of creditors, three additional documents had to be prepared to formally enter an agreement with all the participating creditors. First, an Exchange Offer Memorandum had to be prepared and sent to each eligible debt holder on February 23. The memorandum had to explain in detail the terms of the exchange and ask if an eligible debt holder would like to participate in the debt exchange. Before sending out the memorandum, more discussion had to take place at a technical level on the scope of eligible debt and the exchange procedure.
Second, a Letter of Acceptance (including the supplemental schedule) had to be prepared so that each eligible debt holder, having read the Exchange Offer Memorandum, could notify the exchange (or reconciliation) agent as to how it would like to participate in the debt exchange. A Letter of Acceptance was designed so that an eligible debt holder could notify in a common format its intention to participate in the debt exchange, the maturity, and the currency denomination of the new loan.
Third, a Master Loan Agreement had to be prepared so that all the parties involved (obligors, debt holders, guarantor, and agents) would be able to enter a formal agreement with a single contract. This approach of entering a single contract was considered to be more efficient than to enter hundreds of contracts for each debt exchange.
The DMT held two conference calls with creditors on February 4 and 10, to discuss some remaining technical issues regarding the debt exchange, and then legal advisors had another documentation meeting on February 19 in New York. In those meetings, a number of changes were made to the January 28 term sheet regarding the scope of eligible debt, the debt incurred by overseas subsidiaries, and the details of debt exchange. The changes were reflected in the Exchange Offer Memorandum that was sent to creditors on February 23. Many of the changes were motivated by concerns that the size of the tendered debt might be less than US$18 billion. On the scope of eligible debt, seven more items were included:
Overnight deposits that were originally eligible debt but had been converted into overnights with the same eligible obligor on or after December 24, 1997, and remain outstanding, became eligible;
Call money became eligible as it was considered to be a short-term loan;
Repurchase obligations were included as eligible even if backed by securities issued by local governments, state-owned banks, or specialized banks;
Floating rate certificate of deposits (hereafter FRCD) were interpreted as not constituting a publicly traded security, making a FRCD with a maturity of one year or less eligible;
Long-term loans and long-term FRCDs with annual put options were considered as short-term loans and became eligible;
Banker’s acceptances (B/A) that were money market lines in disguise, with no underlying physical transaction, were considered as a short-term loan and became eligible; and
Syndicate loans became eligible. If some of the creditors in the syndicate were not an eligible debt holder or were not willing to roll over, they were required to submit a waiver.
The January 28 term sheet had to be adjusted to address a loophole in the government guarantee that excluded debt incurred by overseas subsidiaries. From the creditors’ point of view, it was necessary to switch the obligor from the subsidiary to its parent to receive the government guarantee. This could be done in three ways. First, the parent bank was allowed to assume the loan incurred by its subsidiary before the exchange period (e.g. before February 23, 1998). Second, when submitting the letter of acceptance, creditors could choose the option to switch the obligor from a subsidiary to its parent. This, however, took effect only when a written agreement among the three parties (creditor, subsidiary, and its parent) was submitted to the agents (exchange and reconciliation) and reconciliation was successfully completed. Third, the parent bank could guarantee the obligation of its subsidiary, with the government in turn guaranteeing the obligation of the parent guarantor, including its guarantee obligation.
A number of issues were confirmed about the details of debt exchange. First, new loans incurred during the exchange period were also considered eligible, whereas initially only the loans existing as of February 23 were eligible. Second, the maturity of existing debt, once tendered, was automatically extended to the exchange date of April 8. If reconciliation was not completed by April 8, the maturity was to be automatically extended to the next exchange date. Third, since the maturity of reconciled eligible debt expired on April 8 regardless of the original maturity, a breakage fee had to be paid by the obligor to the holder of new loan. The payment, however, was restricted to those debts incurred before December 24, 1997, and expired after February 23, 1998. For debt expiring after June 30, 1998, a breakage fee was not given if it was transformed into a one-year loan.
Fourth, given some skepticism that the total tendered debt might be less than US$18 billion—the original trigger point requiring creditors consent for the exchange to take effect—the trigger point was changed to US$17 billion. A suggestion to change the trigger point to US$16 billion was rejected for fear that this might have a negative effect on investor confidence. Fifth, in case the government as a guarantor had to pay the debt, it was decided to make payments from the Foreign Exchange Stabilization Fund and then replenish the Fund from the government budget. This was necessary since there might be a time lag if payment was made directly from the government budget.
Lastly, creditors were told which merchant banks were commercially sound and viable on March 2, 1998. Out of eleven merchant banks that had eligible debt, nine were determined to be commercially sound and viable. As of February 23, their eligible debt outstanding was US$1.37 billion. Two merchant banks that were deemed nonviable had US$47 million of debt.
Letters of Acceptance & Master Loan Agreement
Letters of Acceptance started to arrive on March 4. The exchange period was originally supposed to expire on March 12, but it was extended up to 5:00 p.m., March 16, 1998. Letters of Acceptance were received from 134 creditors from 32 countries amounting to US$21.84 billion. This was 100.7 percent of the eligible debt outstanding at the beginning of the exchange period (February 23) and 96.4 percent of the eligible debt outstanding on March 16. Exchange to one, two, and three-year maturity loans took up 17.2 percent, 45.0 percent, and 37.8 percent, respectively. The 20 percent cap imposed on one-year maturity loan was not fully exhausted.
The signing ceremony of the Master Loan Agreement was held on March 31, 1998 at Hotel Lotte in Seoul. Seventy-six people, from the Korean government, the IMF, legal councils, lending banks, and borrowing banks, attended the ceremony. From 11:40 a.m. to 12:10 p.m., short speeches were delivered by Kyu-Sung Lee, Minister of Finance and Economy; Yong-Hwan Kim, Vice President of the United Liberal Democrats; and Jong-Keun You, Economic Advisor to the President, gave speeches representing the government. William R. Rhodes, Vice Chairman of Citibank, delivered a short speech on behalf of the lenders, and Se-Pyo Hong, Chairman and President of the Korea Exchange Bank, gave a speech on behalf of the obligors.
The signing took place at 12:10. The Master Loan Agreement was an agreement among seven parties: the obligors, the parent guarantors, the Republic of Korea, the lenders, the syndicate agents, the calculation agent, and the exchange agent. It set forth terms and conditions on the exchange of loans, interests, principals, payments, guarantees, events of default, changes in obligors or parent guarantors, assignments, agents, and so on. Each obligor bank submitted a power of attorney to the DMT, stating that it delegated its right to sign the Agreement to the Korea Exchange Bank. The lenders, by submitting the Letter of Acceptance to the exchange agent, in effect, had already delegated their right to sign the Agreement.
Reconciliation & Government Guarantee
Having received the Letters of Acceptance by March 16, the first round of reconciliation took place from March 17 to April 3. The first exchange date was scheduled to be on April 8, 1998. Ernst & Young, as a reconciliation agent, had to check if each debt tendered by a creditor fell in the eligible debt category, and if the principal amount tendered matched with the information provided by the corresponding obligor. According to the Exchange Offer Memorandum, the reconciliation agent had to report an itemized list of reconciled/unreconciled debts (reconciliation statement) to the three related parties (each eligible debt holder, the Korean government, and each obligor) by April 3, 1998. Only the reconciled debt was assumed to be effectively tendered and be exchanged to a new loan on April 8, 1998. Unreconciled debt had to be reconciled and be exchanged in the later rounds.
A government guarantee was given to new loans (and interest) converted from the eligible debt that had been tendered and reconciled. The guarantee, however, did not cover new loans toward overseas subsidiaries. The total amount of government guarantee was US$21.74 billion plus interest.
The government guarantee process started with drafting of the Guarantee Agreement, describing the details of the guarantee, including the guarantee fees and the sinking fund. This Agreement was sent to each obligor for its signature. The obligor then sent back the signed Agreement to the DMT with the government guarantee application form, the debt repayment schedule, and the debt repayment schedule in case of a default. Upon receipt of these documents, the government reviewed the application. By signing the Master Loan Agreement on March 31, 1998, the government guarantee became legally binding on all relevant parties, and on the first exchange date (April 8, 1998) the guarantee became effective.
Measures to Mitigate Moral Hazard
The government took three measures to minimize moral hazard. First, it charged guarantee fees from the obligors. Second, it required obligors to participate in establishing a sinking fund. Third, obligors were required to submit debt repayment schedules, including prepayments.
Yearly guarantee fees were set to be from 0.2 percent to 1.5 percent of the outstanding debt, depending upon the credit rating and the BIS capital ratio of the obligor concerned. This measure was to address the moral hazard that can arise by giving government guarantee regardless of the obligors’ financial situation. However, it was also important to keep the fee within a reasonable level. It was feared that the borrowing cost including the high guarantee fee would later become a benchmark rate, and thus set the general borrowing costs of the Korean financial institutions.
An obligor with a credit rating equivalent to that of a sovereign was levied 0.2 percent, 0.4 percent, 0.6 percent, 0.8 percent, and 1.0 percent of guarantee, if its BIS capital ratio was above 8 percent, 7-8 percent, 6-7 percent, 5-6 percent, and below 5 percent, respectively. An obligor with a credit rating lower than that of a sovereign was levied 0.3 percent, 0.6 percent, 0.9 percent, 1.2 percent, and 1.5 percent of guarantee fee if its BIS capital ratio was above 8 percent, 7-8 percent, 6-7 percent, 5-6 percent, and below 5 percent, respectively. A credit rating was considered to be equivalent to that of a sovereign if either rating from Moody’s or Standard & Poor’s was the same as that of a sovereign. Guarantee fees in the Korean won were collected every six months on each interest payment date. The amount of revenue collected from this guarantee fee totaled approximately US$150 million.
A sinking fund was established by requiring each obligor to deposit 3 percent of its outstanding debt at the Foreign Exchange Stabilization Fund in U.S. dollars. Contributions to the fund started on May 7, 1998, with 0.25 percent of outstanding debt being contributed each month until April 7, 1999. Obligors were allowed to retrieve their deposits as they made repayments. There was also a penalty for late deposits, the penalty being an additional deposit of oneyear LIBID+100 basis points times the delayed amount. The deposit was remunerated once a year, the amount being one-year LIBID at the time of initial deposit times the average deposit outstanding. The deposits could not be provided as collateral.
Loan Transfers & Prepayments
According to the Master Loan Agreement, lenders were allowed to transfer their loans to other financial institutions. In the first three years, there were 124 transfers amounting to US$1.2 billion, or over 5 percent of total new loans. A significant amount of that, however, was inter-branch transfers within the same bank. There were also changes in obligors as banks merged and overseas branches were liquidated.
As of April 2001, all loans that were exchanged in April 1998 have been fully repaid: there were no defaults. Instead, obligors prepaid significant amounts of loans in advance. This indicates that obligors did not suffer from moral hazard. Banks strived to prepay loans with interest rates higher than prevailing market rates. According to the initial debt repayment schedule, obligors had to repay US$3.76 billion by April 1999, US$9.79 billion by April 2000, and US$8.20 billion by April 2001. By exercising the prepayment option, the obligors instead repaid US$4.18 billion in April 1999, US$8.75 billion in October 1999, US$6.76 billion in April 2000, US$2.12 billion in October 2000, and US$0.26 billion in April 2001.
Ex post, such prepayments also lowered the effective spreads. By replacing the original loans into lower-spread loans, the obligor banks were able to lower the effective spreads to 231 basis points for the two-year tranche and 217 basis points for the three-year tranche compared with original spreads of 250 and 275 basis points, respectively.4
Analyses of the Restructuring Program
Government Guarantee and Moral Hazard
One of the unique aspects of debt restructuring in Korea was the provision of a sovereign guarantee. Although it was acknowledged that a government guarantee was an effective tool to encourage creditors to participate in the program, it raised concerns that it might aggravate moral hazard among the debtors and the creditors. In this section, we examine the data to see if these concerns actually materialized.
Our approach is to guess the kinds of behavior creditors would have taken if they fell back into the habit of blind lending due to the government guarantee. Three testable outcomes were considered.
First, before committing to the maturity extension program, creditors would not bother to switch their short-term loans from poor to better quality debtors. That is, from the time creditors knew about the existence of government guarantee at the end of 1997 until the last day of the exchange period on March 16, 1998, creditors would not withdraw their loans from poorer quality banks to lend to better quality banks.
Second, when tendering the maturity extension offer, creditors would not discriminate between poorer quality banks and better quality ones. In this case, creditors’ average participation in the maturity extension program would be no greater for better quality debtors than for poorer quality debtors.
Third, once creditors have tendered the maturity extension offer, they would choose the length of maturity independent of the banks’ quality. That is, the average maturity creditors tendered would not be longer for better quality banks than for poorer quality banks.
Figures 2, 3, and 4 show the results. Figure 2 depicts the average growth rates of eligible debt over a period between December 31, 1997, and March 16, 1998. Comparison is made between those banks with a BIS ratio above 8 percent and those with a ratio below 8 percent. On average, eligible debt increased by 5 percent in banks with a high BIS ratio, while it decreased by 23 percent in banks with a low BIS ratio. As a robustness test, the growth rate of eligible debt is recomputed over the February 23 - March 16 sub-period. During this period, which corresponds to the exchange period, eligible debt on average increased by 34 percent in banks with a high BIS ratio, while it increased by only 7 percent in banks with a low BIS ratio.
Figure 1.Time Table for Debt Exchange Figure 2.Growth Rate of Eligible Debt
Source: Ministry of Finance and Economy, ROK.
Figure 3.Participation Rate by Obligor Group and BIS Ratio
Source: Ministry of Finance and Economy, ROK.
Figure 3 depicts creditors’ average participation rate to the maturity extension program. Three obligor groups are considered: nationwide commercial banks, local commercial banks, and merchant banks. Value-weighted averages are computed to control for the possibility that creditors with small eligible debt might show lower participation rates. The participation rate is measured by dividing the amount of loans tendered and reconciled as of April 3, 1998, by the amount of eligible debt as of March 16, 1998, the last day of the exchange period. For each obligor group, the creditors’ participation rate is higher in those banks with a high BIS ratio than in those banks with a low BIS ratio.
Figure 4 depicts the average maturity of newly tendered loans. The valueweighted average maturity is computed separately for obligors with participation rate below 95 percent and those above 95 percent. Regardless of the participation rate, the average maturity of new loans is greater in banks with a high BIS ratio than in banks with a low BIS ratio.
Figure 4.New Loan Maturity by Obligors’ Participation Rate and BIS Ratio
Source: Ministry of Finance and Economy, ROK.
These results show that creditors were not blind to the quality of banks when making their decisions on lending, withdrawing, extending maturity, and choosing the maturities. Although the differences are relatively small and we did not formally test the statistical significance of the differences, the pattern is persistent enough to suggest that creditors did not fall back into the habit of blind lending. Despite the government guarantee, it seems that creditors did learn a lesson and became more cautious toward banks with poor quality.
As another way to shed light on the moral hazard issue, we examined if the short-term debt ratio started to creep up again after the government guarantee. If moral hazard actually took place, debtors would not mind taking short-term debt, since the government would step in and guarantee the payments in times of trouble, and creditors would not mind short-term lending if they believed that the government would step in and guarantee the payments when debtors face a problem.
Figure 5 shows a time-series of the ratio of short-term debt to total debt in the Korean banking sector including the merchant banks. Before the end of 1996, the ratio was near 60 percent. In the first half of 1997, the ratio started to fall and this trend accelerated in the second half as foreign banks refused to roll over the maturing loans. Then, in April 1998, the ratio dropped again as US$21.74 billion of short-term loans were exchanged into one, two, or threeyear loans. The short-term debt ratio started to creep up again in early 1999, mainly due to the repayment of new loans provided as a part of the maturity extension program. Since the second half of 2000, the ratio has stabilized at about 35 percent, considerably lower than in the midst of the crisis in late 1997.
Figure 5.Short-term Debt Ratio of Commercial & Merchant Banks
(Ratio of short-term debt to total debt)
Source: Ministry of Finance and Economy, ROK.
For moral hazard to take effect, the interest rate applied to new loans should not be set at a penalty rate, so that debtors would not have any incentive to make prepayments. However, Korean banks made significant prepayments during the past two years, which indicates that the interest rates were set at penalizing levels. Figure 6 shows this. Originally, obligors had to repay US$ 3.76 billion by April 1999, US$9.79 billion by April 2000, and US$8.20 billion by April 2001. Instead, by exercising the prepayment option, they repaid US$4.18 billion in April 1999, US$8.75 billion in October 1999, US$6.76 billion in April 2000, US$2.12 billion in October 2000, and US$0.26 billion in April 2001. These prepayments were encouraged by the measures the government introduced to minimize moral hazard among the debtor institutions, as explained above.
Figure 6.Debt Repayment by Interest Payment Date
(In billions of U.S. dollars)
Source: Ministry of Finance and Economy, ROK.
Effectiveness of the Restructuring Program
Another unique aspect of debt restructuring in Korea was that it rescheduled only bank loans. Other forms of credit such as corporate loans were not covered. This raised concerns that foreign creditors might withdraw from the corporate sector as their exposure to Korean banks increased with the maturity extensions. Figure 7 shows that the financial sector’s long-term debt (LTD) increased with the maturity extensions in early 1998, but this only seems to have reduced the financial sector’s short-term debt. The corporate sector’s long-term debt remained stable. Although the corporate sector’s short-term debts have been decreasing, the drop seems to have taken place before the maturity extension in April 1998, with most of the drop between the end of 1997 and March 1998. Even if this drop was a preemptive measure to reduce exposure in advance, the magnitude was moderate, and did not pose any threat to the success of the restructuring program.
Figure 7.External Debt by Obligors
(In billions of U.S. dollars)
Source: Ministry of Finance and Economy, ROK.
Another concern during the exchange process was that creditors with relatively small amounts of eligible debt would have a low participation rate. Three reasons were behind such concern. First, those creditors would not think their withdrawal would trigger systemic risk to the world economy. Second, those creditors usually did not have any operation other than their loans. Third, the Debt Management Team and the central banks in creditor countries must have paid more attention to those creditors with large eligible debt. The valueweighted average participation rate among creditors with eligible debt below US$100 million was 78 percent, while the average participation rate among creditors with eligible debt above US$100 million was 98.15 percent.
Creditors that did not participate in the New York meeting in late January showed lower rollover rates than those who did participate in the meeting. Among the nine countries with eligible debt between US$100 million and US$500 million, only Canada and Switzerland participated in the New York meeting. Canada and Switzerland had a 99.1 percent average participation rate while the other seven countries had only 85.6 percent participation rate.
A number of factors contributed importantly to the success of the Korean debt restructuring process.
First, it was wise for the Korean government to forcefully oppose the proposal made by J.P. Morgan. Making exchange and new cash offers simultaneously would have lowered the possibility of success compared with the sequential approach supported by the Korean government. The modified Dutch auction mechanism proposed by J.P. Morgan would have led to a much higher interest rate. Persuasive efforts conducted by the Korean government before the New York negotiation paid off and J.P Morgan’s proposal lost center stage at the negotiation tables.
Second, it was wise for the Korean government to speed up the process of negotiation and documentation. The negotiation took less than a month and the documentation took only two months. By delaying the process or, at the extreme, declaring a moratorium, the Korean government could have obtained more favorable terms on existing debts. But to eliminate economic uncertainty and restore investor confidence, it was better to accelerate the process.
Third, the government guarantee of rolled over debt may have helped. It not only made the loans relatively safe, it also freed capital that would have been set aside to abide by the BIS rule. Given that Korea was an OECD member country, the sovereign guarantee transformed rolled over loans into assets with zero percent risk weighting. This was especially attractive to those creditor banks that had suffered capital erosion due to poor performing local stock markets.
Fourth, unlike Mexico, Korea is not endowed with natural resources such as crude oil that could be readily sold for foreign exchange. This suggests that some creditors may not have considered the government guarantee to be fully credible. There must have been other reasons why creditor banks participated in the restructuring program. The size of the Korean economy is one candidate. During the crisis, the G-10 central banks explicitly told the banks under their jurisdiction that any failure to roll over credit lines to Korea would trigger a systemic risk to the world’s financial system. Another candidate is the confidence in the Korean economy. More than thirty years of outstanding economic performance may have imbued a belief in the creditor banks that the Korean economy would successfully recover from the crisis.
Fifth, aggressive road shows conducted to maximize the number of creditor banks participating in the debt maturity extension program were instrumental. The tentative term sheet agreed upon in New York only involved thirteen creditor banks from seven countries. This meant that Korea had to persuade the remaining creditors to have a meaningful amount of debt rolled over. Later the total number of creditor banks participating in the program turned out to be 134 from 32 countries. Such a good result would not have been achieved without the carefully organized and well-conducted road shows by the government and the obligors.
Sixth, the Korean government made sure that debtors receiving a government guarantee did not fall into the trap of moral hazard and resume excessive short-term borrowing. It charged debtor banks guarantee fees according to their risk profiles, it required debtor banks to participate in establishing a sinking fund, and it required debtor banks to submit debt repayment schedules, including prepayments. As a result, the Korean banking sector was able to keep its short-term external debt at about 35 percent of total debt, and make significant prepayments on the rolled over debts. Creditors did not fall into the habit of blind lending because of the guarantee.
Seventh, it was helpful to link the supplemental financial support package with the voluntary maturity extension by the international banking community. From the participating governments’ point of view, it would have been politically damaging if the tax money provided to Korea were only used to pay back Korean banks’ debts to international banks. As such, the participating governments made it clear that the disbursement from the package was contingent on the creditors taking a haircut in the form of voluntary maturity extensions. This, in turn, had the effect of telling the creditor banks that once they extended the maturity of their loans, a significant amount of money would be set aside to make these loans safer.
Eighth, Korea was fortunate to have two outstanding veterans on emerging market debt restructuring: William Rhodes, who chaired the negotiation process in New York and who later accompanied the Korean delegation on many road shows, and Mark Walker, who worked as the legal advisor to the Korean government. It also helped to have appointed outside financial advisors at a nearly stage and to have worked closely with the IMF.
Korea’s experience in debt restructuring during a crisis makes the proposals suggested by the Korean government in April 1999 regarding private sector involvement more convincing.5 In essence, the Korean proposal is to create a pre-established program for debt restructuring and establish a common channel through which the international financial community communicates with the debtor government. The Korean government believes that if there had existed such a mechanism at the time of the crisis, it would have saved significant amounts of time, energy, and money.
Specifically, the government proposed establishing an ad hoc committee for debt workout comprised of representatives from the debtor and creditor governments, central banks from G-7 nations, the IMF, and other relevant international organizations. The committee would deliberate and reach collective decisions on existing private sector debts. In the 1998 restructuring, the discussion initially started among G-7 governments and the IMF. With their persuasion, creditor banks became involved. And lastly, the Korean government representing the debtor banks participated in the deliberation. If such a committee were pre-established, deliberation between the creditor and debtor banks could have started much earlier.
The government also proposed that the provision of emergency funding by the IMF be linked to the debt workout program arranged by the ad hoc committee. In the 1998 restructuring, the US$57 billion rescue package was initially not linked to debt restructuring by the private banking community. Later, as a way of inducing voluntary rollover and also as a way to avoid political damage, the countries participating in the supplemental financial support package made it clear that disbursement was conditioned on voluntary debt restructuring by the international banking community.
In order to provide the needed time for negotiations, the government also proposed that the committee recommend an automatic standstill for three months. In the 1998 restructuring, creditor banks initially rolled over their credit maturing at the end of 1997 until the end of January. In mid-January, they extended the maturity again until March 31, 1998. The rollovers, however, were not automatic. Nor were they legally binding. Many creditor banks withdrew their loans despite the decision by a number of large banks to roll over loans.
The government also proposed to form a sub-committee of creditors where decisions on debt workout issues could be made either on a majority basis or by a consensus of two-thirds. In the 1998 restructuring, the Korean government spent more than two months contacting each individual creditor institution. If the debt workout decision was made collectively under such a subcommittee, it could have saved significant amounts of time and resources.
Lastly, the government proposed that international financial institutions provide an advisory group of experts to help the committee in terms of legal and technical assistance in the debt restructuring process. Such was not the case in the 1998 restructuring. The Korean government had to employ a team of international experts on its own.
The Korean government believes the above proposals will help ensure constructive private sector involvement in future crisis.
Information used in this paper mostly came from internal documents of the Korean government, mainly the Ministry of Finance and Economy. A number of selected documents are listed below.
Documents in Korean
Progress Report on Debt Maturity Extension: December 1997 - January 1998
Progress Report on the Activities of Debt Management Team
Bill for Approval on the Sovereign Guarantee of External Foreign Exchange Debt by Domestic Banks Incurring in 1997 and 1998
Bill for Approval on the Sovereign Guarantee of Foreign Exchange Debt by Bank of Korea and Foreign Exchange Banks Incurring in 1998
Official Directive on the Negotiation for Debt Restructuring
Government Guarantee Agreement
Establishment of Sinking Fund Regarding the Guarantee on Foreign Exchange Debt
Documents in English
J.P. Morgan & Co., Korean Financing Proposal (various versions)
Korea’s Financing Plan for 1998
Term Sheet (various versions)6
Lee, Peter, “Korea Stares into the Abyss,” Euromoney, (March 1998)
Debt Maturity Extension Program: Questions and Answers
Exchange Offer Memorandum
Letters of Acceptance
Master Loan Agreement
Eligible Debt by Obligors & Creditors
Tendered Debt by Obligors & Lenders
Ernst & Young, Reconciliation Statement
Ministry of Finance and Economy, New International Financial Architecture: Korea’s Perspective (April 1999)
IMF, Involving the Private Sector in Forestalling and Resolving Financial Crisis (April 1999)
IMF, “Private Sector Involvement in Crisis Prevention and Resolution: Market Views and Recent Experience,” International Capital Markets (September 2000)
Special thanks go to Mark Walker at Cleary, Gottlieb, Steen, & Hamilton, Hong-Sung Moon at the Korean Ministry of Finance and Economy, Min-Seop Song at the Korea Exchange Bank, and David Behling at the KDI School of Public Policy and Management for their useful comments. Thanks also go to Sang-Jin Han at Cleary, Gottlieb, Steen, & Hamilton, Adam Cooper at Ernst & Young, and Yong-Soo Park at the Korea Development Bank for providing useful data sets. The views expressed herein are those of authors and do not necessarily reflect the views of the Ministry of Finance and Economy, or of any other organization with which the authors are or have been affiliated to, or of the people who provided help. A more detailed version of this paper can be found from the KDI School Working Paper No. 01-06 (http://www.kdischool.ac.kr/library/wpaper_in.html).
Most of the information in this part is taken from Lee, “Korea Stares into the Abyss,” Euromoney (March 1998).
Mark Walker was known to have represented the Mexican government in its external debt matters during the crisis of 1995.
See KDI School Working Paper No. 01-06 for more detail on the activities of the debt management team.
KDI School Working Paper No. 01-06 explains how the effective spreads are calculated.
Ministry of Finance and Economy, New International Financial Architecture: Korea’s Perspective (April 1999).
The title of the January 28 version is “Proposal with Regard to the External Debt of Korean Commercial, State-Owned and Specialized Banks (including Overseas Branches, Agencies, and Certain Foreign Banking Subsidiaries) and Merchant Banks.”