Hanjin default fallout?

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The latest and perhaps the most sensational business news, because of the financial magnitude, ever to hit town in recent memory is the legal filing under the Financial Rehabilitation and Insolvency Act (FRIA) of a corporate rehabilitation plan by Hanjin Heavy Industries and Construction Co. Philippines (Hanjin), the largest investor and biggest employer in the Subic Bay Metropolitan Authority (Subic) in Olongapo, Zambales.

It is a legal move of a corporate debtor to seek protection from the court, specifically to stop payment on the loans and to prevent the creditors from taking unilateral action on the debtor’s assets

Hanjin is a shipbuilding company that invested over $2.3 billion in Subic in early 2000 and employed at its peak 30,000 workers from the different cities and towns in Central Luzon. Largely because of Hanjin’s operations, the Philippines at one point became the fourth largest shipbuilder in the world. Although its workforce is currently down to about 23,000 workers, it still very much is the biggest employer in Subic. Its outstanding loans of P21.6 billion from the local banking system alone represents the largest bank default in the history of our country. This number does not include reported borrowings of as much as $900 million from Korean banks.

A corporate rehabilitation plan under the FRIA is basically an admission of a borrower that it is no longer able to pay off its debts to its creditors. It is a legal move of a corporate debtor to seek protection from the court, specifically to stop payment on the loans and to prevent the creditors from taking unilateral action on the debtor’s assets that could unreasonably impair the company’s ability to continue operations and prejudice other creditors of the distressed debtor, particularly the unsecured creditors and others such as suppliers and employees, pending the court’s approval of a rehabilitation plan. To be approved, the plan will have to demonstrate that the business can still be viable if given more time and the appropriate circumstances, such as an extended deferment of principal payments, a cutback on the lenders’ interest charges and penalties or a recapitalization of the company’s capital base either through new capital being infused or through an acquisition by another corporation.

From my own local banking experience, I have seen that the courts tend to give the benefit of a doubt to a distressed debtor and not allow the secured creditors to be quick to the draw to just foreclose on the mortgaged assets in order to pay themselves off. The court would usually be quite sympathetic to the fate of the displaced employees and the unsecured claimants in the event of a prolonged liquidation. I have seen situations where the conversion of debt into some form of equity, deferment of any principal repayments and forbearance of interest charges and penalties have been par for the course of a court-approved rehabilitation plan.

The court would usually be quite sympathetic to the fate of the displaced employees and the unsecured claimants in the event of a prolonged liquidation.

Notwithstanding a new lease on the debtor’s corporate life through a rehabilitation plan, such a structure, in reality, is already an acknowledgement on the part of the creditors that they will have to take a hit on their exposure. Some losses on the defaulted loan, if not all of it, on the part of the lenders is an inevitability and more prudent lenders will likely already start providing for the eventual loss notwithstanding the loan restructuring.

In the case of Hanjin, two of the affected banks, in particular Bank of the Philippine Islands and Banco de Oro, have already publicly acknowledged that their exposures will be offset by loan loss provisions they have already set aside previously for such situations. How then will the inevitable losses arising from Hanjin affect the lender banks and the banking system in general? In particular, is the financial stability of the banks involved a concern?

This question, which was actually asked of me by a friend, is not surprising. The general public, as we have seen in so many occasions, can easily be swayed by blaring headlines and social media chatter. In this case, however, the early declaration of confidence in the banking system by Bangko Sentral ng Pilipinas Deputy Governor Diwa Guinigundo should nip in the bud any concerns that the bank depositors might have regarding the safety of their deposits.

Furthermore, all the banks involved are universal banks with substantial capital that can adequately absorb whatever losses will be incurred.

Will an approval of the rehabilitation plan ensure a successful turnaround for the business and everything will quickly revert back to how what it was before? Unfortunately, my own view is less optimistic. In these kinds of scenario, the process of trying to make sense of the total liabilities and to establish the rightful creditors, to identify the tangible assets that can truly generate values, to agree on the restructuring agreement that will have to be threshed out between the banks and Hanjin, will all be exceedingly slow and toxic. It will require a lot of compromises on all sides that will really be at the end not to the full satisfaction of all. This process could literally take decades to complete.

The only real possibility for a quick resolution is if a white knight will emerge to take over Hanjin. In such a scenario, however, I would expect that hefty discounts on the company’s book values and the banks’ loan exposures, that will surely be demanded by any white knight at this stage, will be the most critical hurdles to overcome.
Until next time… one big fight!

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