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Cheng Hoon Lim is an Economist in the Asia and Pacific Department and Charles Woodruff is the Principal Financial Specialist in the Private Sector Development Department. The views expressed in the paper are those of the authors and not necessarily those of the IMF or the World Bank. The authors are grateful to John Ryan, an international consultant on insolvency procedures, and to the staff of the Philippine Securities and Exchange Commission for their valuable contributions.
This is based on data for publicly listed banks as of end-June 1997.
For 1997 as a whole, 21 companies filed for suspension of debt payments compared to a total of 50 since 1982.
PAL made a net loss of ₱8.08 billion in the year to March 1998, a threefold increase from its previous year’s loss of ₱2.5 billion. On September 17, four days prior to submitting a rehabilitation plan, PAL announced it was shutting down due to insurmountable losses and following the breakdown of negotiations between management and the labor unions.
In addition, the central bank provided cover to unhedged borrowers using the non-deliverable forward facility to ease pressures on the peso, and for a brief period last year, suspended the sale of non-deliverable forward contracts from onshore banks to offshore counterparties.
Accounting standards in the Philippines which is based on the International Accounting Standards Council allow foreign exchange losses associated with loans to acquire specific assets to be added to the value of the assets or amortized over the remaining life of the loan in question. The former creates a gain from revaluation equal to the foreign exchange loss and the net worth of the borrower remains unchanged. See Section IV below.
Of course, a better assessment of the relative exchange rate versus interest rate effect can be obtained by looking at individual corporate balance sheets and taking into account the variance across companies. This exercise asssumes all maturing debt is rolled over.
The 9 percent rate is the current interest rate on foreign currency deposit unit loans. Interest rates on existing short-term foreign debt are lower, at LIBOR plus 200–250 basis points (7–8.5 percent).
If the total amount of hedged corporate liabilities was 17 percent of total liabilities (assuming only 25 percent of foreign currency denominated liabilities are hedged), the net worth of the corporate sector would decline by 2.7 percent of GNP and the debt service burden would rise by 0.25 percent of GNP on a 10 percent depreciation of the peso.
Note that in real terms, bank prime lending rates are now close to pre-crisis levels.
Only 222 companies out of the top 1,000 corporations in the Philippines are publicly listed on the stock exchange, with a total market capitalization of ₱1,137 billion (40 percent of GNP). The relatively small size of the stock market reflects the reluctance of family owned firms to go public as most prefer to rely on internal sources of funds rather than raising equity or debt from the capital markets to finance their expansion.
In Korea, large corporate groups (known as chaebols) are prohibited from acquiring commercial banks but are allowed to acquire controlling stakes in nonbank financial institutions. Chaebols used their affiliated nonbank financial companies (merchant banks, finance companies and insurance companies) to finance their activities within the group (see Republic of Korea: Selected Issues, SM/98/99).
Engineered swaps work as follows: (i) bank customer A exchanges pesos for dollars at the bank’s forex subsidiary at the current spot exchange rate, and deposits dollars in FCDU account; (ii) FCDU makes dollar loan to bank customer B, who if requiring peso loan, would sell dollars to forex subsidiary for pesos; (iii) in order for bank customer A to gain at least the equivalent of a peso-denominated investment, the bank offers bank customer A a forward contract that would promise to deliver the equivalent yield of a peso investment. Alternatively, the bank can enter into a non-deliverable forward contract (NDF) with bank customer A. This allows the dollars to remain in the bank and for the bank to benefit from continued dollar intermediation.
The exchange rate risk is borne by the corporate borrower (unless hedged) who earns in pesos but borrows in dollars; and the market risk may arise when banks conceal their mark-to-market trading losses by rolling over NDFs at off-market rates.
In addition, while USGAAP requires that all fixed assets be valued at their historic cost, net of depreciation, PAS/IASC permits enterprises to reappraise their fixed assets, a feature that allows inflation to be taken into account periodically. Thus, with the approval of the SEC, companies with negative retained earnings can improve the appearance of their balance sheets by using the gains created by the revaluation of fixed assets to wipe out a retained earnings deficit. This practice, known as “Quasi Reorganization,” is used to create the appearance of “creditworthiness.”
The analysis was based on evaluating if total cash available for debt service over the next 12 months was sufficient to cover bank loans shown as current liabilities and the current portion of long term debt.
Provisions on nonperforming short-term loans can be reversed if such debt can be restructured into longer maturities, or alternatively loans can be recovered through foreclosure actions.