Debt debate on problem loans

EARLY THIS MONTH the leading contenders in Thailand's next election tabled policies for dealing with the high level of bad loans overhanging the country's banks. How best to tackle recalcitrant debtors has assumed major significance in the campaign--polls are due before year-end--with both the ruling Democrats and the opposition Thai Rak Thai Party advocating government bailouts of varying magnitude.

But although Thailand's two main political parties are pushing for state action to untangle problem debts, not everyone believes that more government involvement in the banking industry is a good idea. For the authorities to weigh in afresh at this late stage and nationalize banks' bad loans would be costly and would achieve little for the real economy. "It's too late now to implement a national asset-management corporation," says Kenneth Ng, head of research at ING Barings Securities Thailand in Bangkok. "Thailand has already gone down the market-led path. To do a sudden turnaround would raise new problems of moral hazard."

No one denies that the Thai banking system is in deep trouble. More than three years after the devaluation of the Thai baht signalled the start of a brutal economic contraction, many borrowers are still failing to service loans from the country's banks. True, the proportion of bad debt has fallen from its 1998 peak, when almost half of all bank loans, 2.4 trillion baht ($57 billion at today's rates), were classed as nonperforming. But the progress toward reducing bad debts held on banks' books has been glacial. At the end of July, the last month for which figures are available, banks' bad loans still amounted to 31% of their total lending.

Politicians from both leading parties have identified this as a major obstacle to sustaining Thailand's faltering economic recovery. They argue that the overhang of bad debts is deterring banks from extending new loans. Without access to credit, companies are unable to invest and expand their businesses. As a result Thailand's recovery has lagged behind that of other regional economies. Growth, forecast at 4.5% this year, compares unfavourably with rates of around 7.5%-8% expected from Malaysia and Singapore. Supporters of state intervention argue that if the burden of bad loans could be lifted, the banking system could resume lending and Thailand's growth could get back on track.

Thaksin Shinawatra, leader of Thai Rak Thai, is promising that if he's elected premier, he will set up a national asset-management company to take over bad loans. The ruling Democrat Party, following the policies of Finance Minister Tarrin Nimmanahaeminda, has long resisted calls to follow that course, opting instead for a market-led solution. Now, however, Deputy Prime Minister Supachai Panitchpakdi has said a future Democrat government will set up an asset-management company to buy the 10%-15% of bad loans that the party says cannot be restructured. Some industry analysts, however, believe the true proportion of such "absolute" bad loans is far higher--a third, or even a half, of all bad loans.

Taking the Plunge

Neither party's policy would be straightforward to implement. Among the knottier problems would be fixing the price at which the state-owned asset-management company would buy problem loans from banks. Any commercial managers engaged by the government to run the company would look to buy loans at market rates. The most recent benchmark was set in July when DBS Thai Danu Bank disposed of bad loans with a face value of 30.6 billion baht by selling them at auction to a unit of U.S. investment bank Lehman Brothers. By doing so DBS Thai Danu effectively cleaned up its books, reducing bad loans to an acceptable 10% from 34% earlier. But it paid a heavy price, accepting as payment just 29% of their face value.

Able to draw on the deep pockets of its parent, DBS Bank of Singapore, DBS Thai Danu could afford such a drastic haircut, but few other Thai banks are in such an enviable position. So far, according to industry analysts, Thai banks have set aside provisions sufficient to cover losses on around 50% of their bad loans. Selling off such loans at 29 cents in the dollar would eat deeply into their capital base, undermining their ability to meet regulatory capital requirements. With stockmarket conditions poor, raising fresh capital would prove expensive and involve diluting ownership to a degree that bank shareholders would be reluctant to accept.

Alternatively the government could extend a helping hand to the banks, buying the problem loans at above market rates, say at 50 cents in the dollar, as Thai Rak Thai politicians have suggested. But that course would carry both political and economic risks. Not only would it lay the government open to charges of bailing out rich bank owners at the expense of poor taxpayers; it would also oblige the government to issue bonds to fund the bailout at a time when levels of public debt are approaching 40% of GDP and alarming potential investors.

In addition, a government bailout would introduce a further dimension of moral hazard. Bankers and analysts agree that a significant number of bad debts are what they call "strategic" nonperforming loans--loans that borrowers could service but, lacking any effective compulsion to do so, choose not to.

"A great deal of the nonperforming-loans problem stems from the failure of the judicial system," says James Stent, senior executive vice-president at Bank of Asia, the Thai bank acquired two years ago by Dutch banking giant ABN Amro. Although new bankruptcy and foreclosure laws were passed in March last year, Stent says, "they have not been as effective as they should have been, because the courts aren't functioning properly."

Despite the opening of a dedicated bankruptcy court in June last year, Stent's words are echoed throughout Bangkok's financial community, which complains bitterly that Thailand's legal system is deeply inadequate for the task at hand. According to Therapong Vachirapong, assistant vice-president responsible for strategy at Merrill Lynch Phatra Securities in Bangkok, the weight of the caseload and the shortage of suitably qualified or experienced personnel mean it would take another two to three years to clear the current backlog of cases, even if Thailand's two dozen or so business judges sat for 24 hours a day, seven days a week.

With a small probability of facing court sanction any time soon, debtors have little incentive to negotiate restructuring deals with their banks except on extremely favourable terms. The prospect of a government bailout could further harden the position of opportunistic nonperformers, persuading them to hold out for even more-advantageous deals.

In an attempt to resolve the situation, the Finance Ministry has proposed setting up an independent arbitration system to facilitate debt restructuring. Most observers are sceptical, however, saying there's no reason why arbitration should succeed where previous negotiations have failed. Some believe arbitration could even prove counterproductive, further delaying cases from reaching the courts.

Beef up the law

The answer, believe many observers, lies not in extending bailouts to the banking system but in beefing up bankruptcy laws and streamlining court procedures. Threatened with effective court action, they argue, borrowers would be encouraged to come to terms with their creditors and the level of bad loans would fall sharply. Where restructuring deals prove impossible, an improved legal environment would allow banks to foreclose and recover at least some of their money.

It's a solution that holds little appeal for the banks, however. Many of their debtors' assets are held in the form of property, which in Thailand is notoriously illiquid and difficult to value. Bankers fear that by foreclosing and attempting to liquidate debtors' property holdings they could start a property glut that would see the value of their assets eroded even further. Better, they reason, repeatedly to reschedule or restructure debts and hope for a government rescue.

Even with a beefed-up legal system, it will still take another two to three years to resolve Thailand's bad-debt problem, and politicians fear the economic drag of such a prolonged debt workout. But it is far from clear that resolving the overhang of nonperforming loans would immediately lead to robust economic growth fuelled by a surge in bank credit. Despite growing last year, Thailand's GDP is still some 3% smaller than its 1996 level. Overcapacity remains endemic, with the Bank of Thailand reporting capacity utilization of just 54% in the second quarter. With such massive levels of spare capacity in the economy, companies have little need to invest and demand for credit is deeply subdued.

Lenders are only too eager to accommodate creditworthy companies whose businesses are expanding, principally those in the telecoms, technology and export industries. But potential borrowers remain risk-averse and banks are facing growing competition from Thailand's emerging local-currency corporate bond market, which offers favourable funding costs. One senior Bangkok banker recounts having approved new credit lines worth tens of billions of baht over the last few months, only to see "almost no drawdown."

"There are too many lenders chasing way too few borrowers," says another. "It's not that Thailand is overbanked. There's just not enough credit demand." Economists estimate it will be two to three years before companies reach full capacity utilization and need to resume borrowing to invest for future growth. That should be sufficient time for Thailand to put its house in order.