Distressed Investing in Australia 2009 - PwC
Distressed Investing in Australia 2009 - PwC
Distressed Investing in Australia 2009 - PwC
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<strong>Distressed</strong> <strong>Invest<strong>in</strong>g</strong> <strong>in</strong> <strong>Australia</strong><br />
A guide for buyers and sellers
About Blake Dawson<br />
Our focus is gett<strong>in</strong>g to the heart of your legal needs and deliver<strong>in</strong>g you commercially astute and practical<br />
solutions. We have a proud history, long stand<strong>in</strong>g client relationships, a passion for challeng<strong>in</strong>g conventions<br />
and thrive on cutt<strong>in</strong>g edge work.<br />
We provide legal services to <strong>Australia</strong>’s lead<strong>in</strong>g companies and <strong>in</strong>stitutions as well as global corporations and<br />
government. We are privileged to work with many of the organisations that are shap<strong>in</strong>g tomorrow’s <strong>in</strong>dustries.<br />
Blake Dawson delivers more than just the law. We value our relationships with our clients and look forward<br />
to work<strong>in</strong>g with you.<br />
Our <strong>Distressed</strong> <strong>Invest<strong>in</strong>g</strong> Practice<br />
Our <strong>Distressed</strong> <strong>Invest<strong>in</strong>g</strong> practice has an established track record of assist<strong>in</strong>g clients to successfully execute<br />
the restructur<strong>in</strong>g, sale or purchase of distressed assets, companies and non-perform<strong>in</strong>g loan portfolios.<br />
Our expertise spans all sectors <strong>in</strong>clud<strong>in</strong>g real estate, energy and resources, manufactur<strong>in</strong>g and f<strong>in</strong>ancial<br />
services and we cover all geographic areas. We br<strong>in</strong>g together a multi-discipl<strong>in</strong>ary team of lead<strong>in</strong>g advisers<br />
from our bank<strong>in</strong>g, restructur<strong>in</strong>g and <strong>in</strong>solvency, corporate, property and tax teams to best structure your<br />
distressed deals. For further <strong>in</strong>formation, please visit our website at www.blakedawson.com<br />
About PricewaterhouseCoopers<br />
PricewaterhouseCoopers provides <strong>in</strong>dustry-focused Assurance, Tax & Legal and Advisory services<br />
for public and private clients <strong>in</strong> four areas:<br />
• corporate accountability<br />
• risk management<br />
• structur<strong>in</strong>g and mergers and acquisitions<br />
• performance and process improvement<br />
We use our network, experience, <strong>in</strong>dustry knowledge and bus<strong>in</strong>ess understand<strong>in</strong>g to build trust<br />
and create value for our clients.<br />
<strong>Distressed</strong> Debt Group<br />
Over the past decade, PricewaterhouseCoopers <strong>Distressed</strong> Debt Group has managed more than<br />
150 sell-side and buy-side engagements <strong>in</strong> over 25 countries. Overall the group has acted for more<br />
than 30 <strong>in</strong>ternational clients, 60 local buyers and various government agencies.<br />
With dedicated staff located <strong>in</strong> <strong>Australia</strong> as well as Asia, Europe and Lat<strong>in</strong> America we br<strong>in</strong>g together<br />
global experience with local capability, no matter where the deal is, to ensure a smooth and seamless<br />
experience. We are also uniquely positioned through our extensive relationships with the pool of global<br />
<strong>in</strong>vestors, to ensure any deal is marketed to the widest possible audience of buyers.<br />
The <strong>Distressed</strong> Debt group is an <strong>in</strong>tegral part of PricewaterhouseCoopers’ Corporate Advisory<br />
and Restructur<strong>in</strong>g practice which has a local presence <strong>in</strong> over 60 countries <strong>in</strong> the world.<br />
© 2010. Blake Dawson and PricewaterhouseCoopers. All rights reserved.<br />
This work is copyright. Reproduction of any part is welcome with prior permission from Blake Dawson and<br />
PricewaterhouseCoopers. Requests and enquiries may be emailed to sarah.wilson@blakedawson.com and<br />
duncan.mcgilligan@au.pwc.com.<br />
<strong>Australia</strong>n laws and regulations are constantly chang<strong>in</strong>g. This publication is <strong>in</strong>tended only to provide a summary of<br />
the subject matter covered. It does not purport to be comprehensive or to render legal advice. No reader should act<br />
on the basis of any matter conta<strong>in</strong>ed <strong>in</strong> this publication without first obta<strong>in</strong><strong>in</strong>g specific professional advice. We <strong>in</strong>vite<br />
you to contact us for any further <strong>in</strong>formation or assistance.<br />
“PricewaterhouseCoopers” refers to PricewaterhouseCoopers, a Partnership formed <strong>in</strong> <strong>Australia</strong> or, as the context<br />
requires, the PricewaterhouseCoopers global network or other member firms of the network, each of which is a<br />
separate and <strong>in</strong>dependent legal entity.
Table of contents<br />
Foreword – Blake Dawson 2<br />
Foreword – PricewaterhouseCoopers 3<br />
Overview – <strong>Distressed</strong> <strong>in</strong>vest<strong>in</strong>g <strong>in</strong> <strong>Australia</strong> 4<br />
1. The who, the how and the why of buy<strong>in</strong>g distressed debt/assets 12<br />
Who buys and sells distressed assets, and why? How big is the global market? What is <strong>Australia</strong>’s<br />
place <strong>in</strong> this market, and what do potential <strong>in</strong>vestors th<strong>in</strong>k of <strong>Australia</strong>? What is the secondary debt<br />
market, and how does it operate <strong>in</strong> <strong>Australia</strong> and offshore?<br />
2. Portfolio debt sales – the key considerations <strong>in</strong> value 18<br />
What determ<strong>in</strong>es the value of a portfolio of an <strong>in</strong>dividual credit or a portfolio of distressed debt?<br />
What are the key steps <strong>in</strong> the adm<strong>in</strong>istration of distressed assets? How do debtholders recover<br />
assets <strong>in</strong> <strong>Australia</strong>?<br />
3. Us<strong>in</strong>g secured debt to control outcomes and obta<strong>in</strong> ownership of the assets 28<br />
What are the legal boundaries with<strong>in</strong> which distressed asset <strong>in</strong>vestors must move? What are the<br />
rights and responsibilities of secured debtholders? How can debtholders best protect the value<br />
of their assets?<br />
4. Recapitalis<strong>in</strong>g distressed listed/unlisted companies 32<br />
How can distressed asset <strong>in</strong>vestors recapitalise their assets? What are the differences between<br />
listed and unlisted firms? How does the adm<strong>in</strong>istration regime <strong>in</strong> <strong>Australia</strong> provide for companies<br />
to be reorganised?<br />
5. Why should an <strong>Australia</strong>n bank sell debt? 36<br />
If <strong>Australia</strong>n banks have felt no need to sell distressed assets until now, why should they consider<br />
it? Reasons <strong>in</strong>clude an <strong>in</strong>creased number of buyers of distressed assets, the <strong>in</strong>creas<strong>in</strong>g dra<strong>in</strong><br />
on management time and focus on workout, the constra<strong>in</strong>ts on capital created by Basel II,<br />
and liquidity constra<strong>in</strong>ts brought on by the global f<strong>in</strong>ancial crisis.<br />
6. How does a non-perform<strong>in</strong>g loan portfolio sale work? 40<br />
What are the steps <strong>in</strong> sell<strong>in</strong>g a non-perform<strong>in</strong>g loan, or a portfolio of loans? How are they priced<br />
and how do sellers achieve the best price. What are the mechanics of servic<strong>in</strong>g the portfolio<br />
dur<strong>in</strong>g and after the sale process? How can sellers best protect their <strong>in</strong>terests?<br />
7. Structur<strong>in</strong>g options for sellers of debt/assets 46<br />
How should banks and other sellers of debt structure their transactions? Options <strong>in</strong>clude outright<br />
sale, a jo<strong>in</strong>t venture arrangement, or securitisation.<br />
8. Tax implications of sell<strong>in</strong>g and buy<strong>in</strong>g debt 50<br />
Tax issues are complex both for the buy side and sell side. What features of the <strong>Australia</strong>n tax system<br />
are relevant for distressed asset <strong>in</strong>vestment? What tax issues should sellers and buyers take <strong>in</strong>to<br />
account at the plann<strong>in</strong>g stage?<br />
Appendix A – Economic outlook 62<br />
Appendix B – Summary of <strong>Australia</strong>n Big 4 Banks Basel II disclosures 64<br />
Useful websites 66<br />
Contribut<strong>in</strong>g authors 68<br />
Contact <strong>in</strong>formation<br />
Back cover
Foreword – Blake Dawson<br />
The emergence and cont<strong>in</strong>ued growth of a secondary market <strong>in</strong> <strong>Australia</strong> for<br />
distressed debts and assets is a sign of the <strong>in</strong>creas<strong>in</strong>g depth and sophistication<br />
of <strong>Australia</strong>’s f<strong>in</strong>ancial markets.<br />
Such a market is beneficial to the <strong>Australia</strong>n economy for at least two key reasons.<br />
Firstly, it adds much needed liquidity <strong>in</strong>to the system, permitt<strong>in</strong>g parties with exist<strong>in</strong>g<br />
positions to trade out those positions. Secondly, it creates a floor for distressed assets,<br />
mean<strong>in</strong>g that any bus<strong>in</strong>ess that is capable of be<strong>in</strong>g restructured is restructured.<br />
Ultimately, by provid<strong>in</strong>g opportunities for new <strong>in</strong>vestors, the chances of preserv<strong>in</strong>g<br />
stakeholder value and cont<strong>in</strong>uity of employment <strong>in</strong> <strong>Australia</strong>n bus<strong>in</strong>esses are maximised.<br />
For lenders and <strong>in</strong>vestors with exist<strong>in</strong>g positions, there is the option of sell<strong>in</strong>g<br />
down their positions <strong>in</strong>to the market. For potential <strong>in</strong>vestors with a knowledge<br />
of distressed <strong>in</strong>vest<strong>in</strong>g techniques, there is the opportunity to <strong>in</strong>vest.<br />
<strong>Australia</strong> is an attractive place to <strong>in</strong>vest. The rule of law prevails and the legislative and<br />
judicial processes are justifiably held <strong>in</strong> high regard. A number of the historical legal<br />
impediments to secondary market trad<strong>in</strong>g have now been removed and the <strong>Australia</strong>n<br />
market is becom<strong>in</strong>g more comfortable with the distressed <strong>in</strong>vest<strong>in</strong>g techniques that are<br />
common features of other markets; these <strong>in</strong>clude “loan to own” strategies; “pre-pack”<br />
formal appo<strong>in</strong>tments; and convertible note <strong>in</strong>vest<strong>in</strong>g. By utilis<strong>in</strong>g these techniques,<br />
an <strong>in</strong>vestor can look to m<strong>in</strong>imise the risks associated with <strong>in</strong>vest<strong>in</strong>g <strong>in</strong> distressed<br />
companies or their assets.<br />
Of course there still rema<strong>in</strong> issues that lenders and <strong>in</strong>vestors must confront. The<br />
Sons of Gwalia decision, for example, has not done much for <strong>Australia</strong>’s reputation<br />
<strong>in</strong> other f<strong>in</strong>ancial markets where shareholders are expressly excluded from compet<strong>in</strong>g<br />
with creditors upon <strong>in</strong>solvency. These issues aside however, distressed debt and<br />
asset trad<strong>in</strong>g is a market not to be ignored. In a time of uncerta<strong>in</strong>ty, it presents<br />
significant opportunity for those who have the appetite.<br />
As market leaders <strong>in</strong> restructur<strong>in</strong>g and distressed <strong>in</strong>vest<strong>in</strong>g, we are committed<br />
to shap<strong>in</strong>g this emerg<strong>in</strong>g market. For this reason we have partnered with<br />
PricewaterhouseCoopers to produce this guide. Cover<strong>in</strong>g the key legal and<br />
account<strong>in</strong>g issues, we hope this guide will arm you with the requisite knowledge<br />
and understand<strong>in</strong>g to participate <strong>in</strong> and take advantage of this excit<strong>in</strong>g market.<br />
James Marshall<br />
Partner, Blake Dawson
Foreword – PricewaterhouseCoopers<br />
“When one door closes another door opens; but we so often look so long and so<br />
regretfully upon the closed door, that we do not see the ones which open for us”<br />
When Alexander Graham Bell wrote this world famous quote it is doubtful that he<br />
had <strong>in</strong> m<strong>in</strong>d the f<strong>in</strong>ancial crisis of 2008/09.<br />
The <strong>Australia</strong>n market is today fac<strong>in</strong>g a period of uncerta<strong>in</strong>ty like it has not faced<br />
s<strong>in</strong>ce the early 90’s. Like then, globally banks today are fac<strong>in</strong>g a rapid build up<br />
<strong>in</strong> non‐perform<strong>in</strong>g loans and companies are fac<strong>in</strong>g unprecedented pressure on<br />
their top and bottom l<strong>in</strong>es. However the market is also a very different one today<br />
to those uncerta<strong>in</strong> days. In today’s market there are so many more options open<br />
to both distressed companies as well as lenders.<br />
There exists a very real opportunity for banks to unlock the hidden value tied up <strong>in</strong><br />
non‐perform<strong>in</strong>g loans. From free<strong>in</strong>g up management time to focus on newer more<br />
press<strong>in</strong>g problems to releas<strong>in</strong>g capital that needs to be set aside aga<strong>in</strong>st all NPLs,<br />
debt sales have a very real place <strong>in</strong> today’s market as has been highlighted by the<br />
American, European and Asian markets experience.<br />
This is why, together with Blake Dawson, we have <strong>in</strong>vested <strong>in</strong> this publication to further<br />
develop the <strong>Australia</strong>n market and to highlight some of the issues around the buy<strong>in</strong>g<br />
and sell<strong>in</strong>g of distressed debt and assets and thereby encourag<strong>in</strong>g the evolution<br />
of this fledgl<strong>in</strong>g market <strong>in</strong> <strong>Australia</strong>.<br />
Please read this with the open m<strong>in</strong>d that Alexander Graham Bell advocates and<br />
help us to help you realise this opportunity and <strong>in</strong> the end maximise recovery<br />
dur<strong>in</strong>g these uncerta<strong>in</strong> times.<br />
Michael McCreadie<br />
Partner, PricewaterhouseCoopers
Overview – <strong>Distressed</strong><br />
<strong>in</strong>vest<strong>in</strong>g <strong>in</strong> <strong>Australia</strong><br />
“<strong>Australia</strong> is really attractive to us...”<br />
...says the manager of a billion dollar global fund dedicated<br />
to <strong>in</strong>vest<strong>in</strong>g <strong>in</strong> distressed assets, who was <strong>in</strong>terviewed for<br />
the purposes of this publication.<br />
Worldwide, distressed <strong>in</strong>vestment is a<br />
US$50 – US$100 billion <strong>in</strong>dustry. As the<br />
consequences of the global f<strong>in</strong>ancial crisis work<br />
their way through the global economy, it is one<br />
of the few areas that is set to grow significantly<br />
<strong>in</strong> the years to come, as <strong>in</strong>creas<strong>in</strong>g numbers of<br />
companies f<strong>in</strong>d themselves <strong>in</strong> difficult f<strong>in</strong>ancial<br />
circumstances and are unable to meet their<br />
debt commitments. <strong>Distressed</strong> M&A <strong>in</strong> the<br />
US alone is set to grow by 93% this year.<br />
<strong>Australia</strong> will follow. The boom years have<br />
been good to the lucky country, but the<br />
global downturn has significant implications<br />
for <strong>Australia</strong>n companies. Export markets<br />
are stressed and the domestic economic<br />
situation has darkened. Companies are lay<strong>in</strong>g<br />
off large numbers of workers, are restructur<strong>in</strong>g<br />
to avoid <strong>in</strong>solvency, and <strong>in</strong> some cases<br />
are fall<strong>in</strong>g <strong>in</strong>to adm<strong>in</strong>istration.<br />
For distressed asset specialists, <strong>Australia</strong> is<br />
an extremely attractive market. Here’s why:<br />
• Opportunities will proliferate as the economic<br />
situation unfolds. The country’s banks are<br />
manag<strong>in</strong>g a larger number of underperform<strong>in</strong>g<br />
loans than they have seen <strong>in</strong> 15 years.<br />
Their workout teams are overwhelmed. In all<br />
likelihood, the supply of non-perform<strong>in</strong>g loans<br />
from <strong>Australia</strong>n banks will multiply as banks<br />
struggle with the new bus<strong>in</strong>ess conditions<br />
and become <strong>in</strong>creas<strong>in</strong>gly comfortable with<br />
the idea of bundl<strong>in</strong>g and sell<strong>in</strong>g poorly<br />
perform<strong>in</strong>g assets to third parties<br />
• The legal and account<strong>in</strong>g frameworks are<br />
clear and comprehensible, unlike a number<br />
of markets <strong>in</strong> the Asian region<br />
• The bus<strong>in</strong>ess operat<strong>in</strong>g environment is well<br />
regulated and stable, with good <strong>in</strong>frastructure<br />
and well developed services<br />
• There is a large base of sophisticated<br />
<strong>in</strong>vestors look<strong>in</strong>g for alternative <strong>in</strong>vestment<br />
opportunities <strong>in</strong> this new and excit<strong>in</strong>g market.<br />
The distressed <strong>in</strong>vest<strong>in</strong>g market <strong>in</strong> <strong>Australia</strong><br />
has historically been very quiet. But this is<br />
likely to change, and change rapidly.<br />
Between December 2008 and January <strong>2009</strong>,<br />
PricewaterhouseCoopers and Blake Dawson<br />
<strong>in</strong>terviewed a number of high profile market<br />
participants, <strong>in</strong>clud<strong>in</strong>g representatives from<br />
<strong>Australia</strong>’s major banks, foreign banks active<br />
<strong>in</strong> the market, fund managers with experience<br />
<strong>in</strong> distressed asset <strong>in</strong>vest<strong>in</strong>g offshore,<br />
and domestic private equity managers<br />
consider<strong>in</strong>g distressed deals.<br />
This overview outl<strong>in</strong>es our conclusions from<br />
those <strong>in</strong>terviews together with research <strong>in</strong>to<br />
the opportunity for the creation of a secondary<br />
or distressed <strong>in</strong>vest<strong>in</strong>g market <strong>in</strong> <strong>Australia</strong>.<br />
This publication outl<strong>in</strong>es the mechanics of<br />
such a market, from the basics of distressed<br />
asset transfer to the structure of such deals,<br />
its legal framework and tax implications.<br />
Understand<strong>in</strong>g how to participate <strong>in</strong> distressed<br />
<strong>in</strong>vest<strong>in</strong>g will be vital <strong>in</strong> the com<strong>in</strong>g months<br />
and years for those organisations that wish<br />
to flourish through the downturn.
<strong>Australia</strong>n banks have never<br />
really thought about debt sales.<br />
They have never really had to.<br />
Senior manager, major <strong>Australia</strong>n bank<br />
Background<br />
<strong>Australia</strong> has had little need for a distressed asset market<br />
until today. A strong economy for well over a decade<br />
has meant there have been relatively few bankruptcies,<br />
non-perform<strong>in</strong>g loans on bank’s books have been well<br />
with<strong>in</strong> manageable limits, and <strong>in</strong>vestors have had a wealth<br />
of positive, growth oriented opportunities to focus on.<br />
Now, we are on the verge of a new market.<br />
A market created by the rapid change <strong>in</strong><br />
economic circumstances, by <strong>in</strong>vestment<br />
capital look<strong>in</strong>g for opportunities <strong>in</strong> an<br />
extremely difficult environment, and by<br />
the need for <strong>Australia</strong>n banks and other<br />
f<strong>in</strong>ancial <strong>in</strong>stitutions to f<strong>in</strong>d solutions<br />
to new problems.<br />
Through a period of 15 years of<br />
un<strong>in</strong>terrupted growth, <strong>Australia</strong>n lenders<br />
have experienced only modest levels of<br />
f<strong>in</strong>ancial distress amongst their customers.<br />
F<strong>in</strong>anciers <strong>in</strong> other parts of the world have<br />
developed efficient markets for transferr<strong>in</strong>g<br />
distressed assets off their balance sheets<br />
to specialist <strong>in</strong>vestment funds and other<br />
<strong>in</strong>vestors dedicated to the sector. But<br />
their <strong>Australia</strong>n counterparts have been<br />
under no pressure to do so.<br />
With the global f<strong>in</strong>ancial crisis roll<strong>in</strong>g<br />
through the <strong>Australia</strong>n economy, f<strong>in</strong>ancial<br />
<strong>in</strong>stitutions are likely to see a sharp<br />
<strong>in</strong>crease <strong>in</strong> non-perform<strong>in</strong>g loans and<br />
other distressed assets. At the same time,<br />
banks’ revenues are reduc<strong>in</strong>g because of<br />
lower demand for credit, and there will be<br />
greater pressure from both shareholders<br />
and regulators to hold <strong>in</strong>creased amounts<br />
of capital aga<strong>in</strong>st impaired assets.<br />
Meanwhile, distressed asset funds<br />
operat<strong>in</strong>g across <strong>in</strong>ternational markets<br />
are eye<strong>in</strong>g <strong>Australia</strong> carefully. The country’s<br />
well structured f<strong>in</strong>ancial markets, rigorous<br />
legal frameworks and clear regulatory<br />
environment give it a competitive<br />
advantage over its regional neighbours,<br />
and a clearly imm<strong>in</strong>ent <strong>in</strong>crease <strong>in</strong><br />
f<strong>in</strong>ancial distress is attract<strong>in</strong>g attention<br />
from those who seek to extract value<br />
from f<strong>in</strong>ancially troubled companies.<br />
Global funds with experience <strong>in</strong> distressed<br />
markets are cashed up and poised on<br />
the sidel<strong>in</strong>es. Over the next few years,<br />
<strong>Australia</strong> may well see the birth of a<br />
vibrant market for these assets, but it<br />
will take a change <strong>in</strong> approach on behalf<br />
of the major f<strong>in</strong>ancial <strong>in</strong>stitutions, and a<br />
few breakthrough deals to kick start it.<br />
Bad news ris<strong>in</strong>g<br />
At the tail end of a 15-year boom, the<br />
<strong>Australia</strong>n economy is fac<strong>in</strong>g numerous<br />
challenges. Seem<strong>in</strong>gly overnight, the<br />
credit crunch and the global f<strong>in</strong>ancial<br />
crisis have brought the country’s longest<br />
unbroken period of growth to a halt.<br />
The years of relatively easy credit that<br />
fuelled the country’s optimism and its<br />
<strong>in</strong>vestment <strong>in</strong> the future have ended.<br />
In 2006, companies were offered<br />
unprecedented amounts of leverage<br />
to f<strong>in</strong>ance their futures and ma<strong>in</strong>ta<strong>in</strong><br />
smooth cash flows. Much of that
activity came to a stop <strong>in</strong> the middle<br />
of 2007 as banks faced serious liquidity<br />
challenges <strong>in</strong> the flow on from the subprime<br />
crisis <strong>in</strong> the US. The early stages<br />
of the credit crunch saw the collapse<br />
of many <strong>Australia</strong>n companies whose<br />
rise had been emblematic of the boom:<br />
Allco F<strong>in</strong>ance Group, ABC Learn<strong>in</strong>g,<br />
Centro and Babcock & Brown be<strong>in</strong>g<br />
the highest profile casualties to date.<br />
The spread of bad news through the<br />
f<strong>in</strong>ancial markets has <strong>in</strong>fected broader<br />
sentiment throughout the economy.<br />
Companies, for many years unable<br />
to recruit enough good people fast<br />
enough, have been lay<strong>in</strong>g workers<br />
off <strong>in</strong> their thousands. Consumers,<br />
a ma<strong>in</strong>stay of <strong>Australia</strong>n prosperity for<br />
over a decade, have stopped shopp<strong>in</strong>g.<br />
Despite fast and deep cuts <strong>in</strong> official<br />
<strong>in</strong>terest rates by the Reserve Bank of<br />
<strong>Australia</strong>, <strong>in</strong>dustry has stopped <strong>in</strong>vest<strong>in</strong>g<br />
and the hous<strong>in</strong>g market has stalled.<br />
Ch<strong>in</strong>a, whose economic health has been<br />
crucial for <strong>Australia</strong>, has also faltered <strong>in</strong><br />
recent months, its export-led GDP growth<br />
stumbl<strong>in</strong>g from over 10% over the last<br />
decade to less than 7% at the end of<br />
2008. Ch<strong>in</strong>a’s unprecedented demand<br />
for commodities placed a floor under<br />
prices for much of <strong>Australia</strong>’s <strong>in</strong>ventory<br />
of natural resources, and underwrote<br />
soar<strong>in</strong>g share prices for the country’s<br />
blue chip m<strong>in</strong><strong>in</strong>g companies and a flurry<br />
of <strong>in</strong>vestment <strong>in</strong> small and medium<br />
sized commodity enterprises.<br />
Ch<strong>in</strong>a also directly <strong>in</strong>vested tens of<br />
billions of dollars <strong>in</strong> <strong>Australia</strong>n resource<br />
enterprises. Much of this <strong>in</strong>vestment is<br />
under pressure to cont<strong>in</strong>ue to perform.<br />
The collapse <strong>in</strong> Ch<strong>in</strong>a’s export markets<br />
is rapidly flow<strong>in</strong>g through to the <strong>Australia</strong>n<br />
m<strong>in</strong><strong>in</strong>g community, and that sector, just<br />
12 months ago the source of a great<br />
deal of economic strength, is undergo<strong>in</strong>g<br />
swift and unpleasant adjustment.<br />
In short, the credit crisis is hav<strong>in</strong>g a<br />
significant impact on <strong>Australia</strong>’s <strong>in</strong>dustries<br />
and enterprises. Many companies with<br />
previously sound bus<strong>in</strong>ess models<br />
have met with unexpected difficulty<br />
when attempt<strong>in</strong>g to roll over their shortterm<br />
loans, caus<strong>in</strong>g sudden and severe<br />
cash flow issues. Many have had to<br />
quickly and radically adapt their bus<strong>in</strong>ess<br />
operations. Others have simply failed.<br />
Accord<strong>in</strong>g to the <strong>Australia</strong>n Securities<br />
and Investments Commission, the number<br />
of companies enter<strong>in</strong>g adm<strong>in</strong>istration <strong>in</strong><br />
<strong>Australia</strong> jumped 10.3% between 2007<br />
and 2008 to 8,300, and the number<br />
of <strong>in</strong>solvency appo<strong>in</strong>tments jumped by<br />
over 6% to 12,770.<br />
Bad loans <strong>in</strong> the system<br />
With the economy <strong>in</strong> freefall, banks and<br />
other f<strong>in</strong>ancial <strong>in</strong>stitutions are brac<strong>in</strong>g<br />
themselves for a major <strong>in</strong>crease <strong>in</strong><br />
distressed assets as companies and<br />
consumers f<strong>in</strong>d themselves unable to<br />
service the loans taken on <strong>in</strong> the good<br />
times. By the end of the last fiscal year,<br />
the major banks had already seen a rise<br />
<strong>in</strong> bad debt charges, up some 174% over<br />
the year to end June 2008. The first half of<br />
calendar 2008 was 54% higher than the<br />
second half of 2007. By some measures<br />
the <strong>in</strong>crease <strong>in</strong> bad debt charges <strong>in</strong> fiscal<br />
2008 was up 183%, represent<strong>in</strong>g 0.41%<br />
of total loans. The <strong>Australia</strong>n bank<strong>in</strong>g<br />
<strong>in</strong>dustry hasn’t seen this level of bad<br />
debt charges s<strong>in</strong>ce 1994, the tail end<br />
of the last downturn.
Our conversations with the major banks<br />
<strong>in</strong>dicate that many workout desks are<br />
already feel<strong>in</strong>g the pressure.<br />
Michael McCreadie, PricewaterhouseCoopers<br />
impaired assetS and BAD debt expense<br />
7.0%<br />
6.0%<br />
5.0%<br />
4.0%<br />
Impaired assets / gross loans & acceptances (left axis)<br />
Bad debt charge / gross loans & acceptances (right axis)<br />
2.5%<br />
2.0%<br />
1.5%<br />
3.0%<br />
2.0%<br />
1.0%<br />
1.0%<br />
0.5%<br />
0.0%<br />
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008<br />
Notes: 2006 onwards based on AIFRS<br />
0.0%<br />
Source: PricewaterhouseCoopers – Perspectives: Major Banks Analysis, October 2008<br />
Domestic Credit Growth<br />
(Annual % growth)<br />
30%<br />
25%<br />
20%<br />
15%<br />
10%<br />
5%<br />
0%<br />
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008<br />
Total Hous<strong>in</strong>g Personal Bus<strong>in</strong>ess<br />
Source: PricewaterhouseCoopers – Perspectives: Major Banks Analysis, October 2008
At the same time, the banks have<br />
witnessed a marked <strong>in</strong>crease <strong>in</strong><br />
impaired assets, up by 137% <strong>in</strong> fiscal<br />
2008, or 0.43% total loans. While this<br />
is still significantly below levels experienced<br />
dur<strong>in</strong>g the 1990s, the banks are also<br />
see<strong>in</strong>g significant <strong>in</strong>creases <strong>in</strong> past-due<br />
loans. Dur<strong>in</strong>g fiscal 2008, loans that were<br />
“past due 90 days or more with adequate<br />
security” <strong>in</strong>creased 29% <strong>in</strong> aggregate.<br />
Our discussions with a number of<br />
workout professionals <strong>in</strong> the major<br />
banks <strong>in</strong>dicate that many are fac<strong>in</strong>g<br />
unprecedented workloads. In many banks,<br />
workout desks are perhaps the only<br />
grow<strong>in</strong>g part of operations, with many<br />
experienc<strong>in</strong>g such growth <strong>in</strong> demand<br />
they fear be<strong>in</strong>g overwhelmed.<br />
While impaired assets and debt charges<br />
are likely to <strong>in</strong>crease significantly, bank<br />
marg<strong>in</strong>s will be under pressure from<br />
slow<strong>in</strong>g credit growth on both the<br />
consumer and bus<strong>in</strong>ess lend<strong>in</strong>g sides.<br />
Total credit growth slowed <strong>in</strong> 2008 to<br />
10.5% from 16% <strong>in</strong> 2007, with growth<br />
<strong>in</strong> bus<strong>in</strong>ess lend<strong>in</strong>g slow<strong>in</strong>g to 13.7%<br />
<strong>in</strong> the year to September 2008 from<br />
over 22% the previous year.<br />
This po<strong>in</strong>ts to a challeng<strong>in</strong>g environment<br />
for the major banks, to say the least.<br />
Th<strong>in</strong>gs are likely to be worse for other<br />
players <strong>in</strong> the f<strong>in</strong>ancial services arena.<br />
The foreign banks, second tier f<strong>in</strong>ancial<br />
<strong>in</strong>stitutions, such as smaller banks, credit<br />
unions and build<strong>in</strong>g societies, as well<br />
as other non-bank f<strong>in</strong>ancial <strong>in</strong>stitutions<br />
are each fac<strong>in</strong>g their own issues<br />
and f<strong>in</strong>ancial stra<strong>in</strong>s.<br />
A fear exists that foreign banks, under<br />
pressure to withdraw capital to support<br />
their home markets, will pull out of the<br />
<strong>Australia</strong>n market, transferr<strong>in</strong>g their<br />
<strong>Australia</strong>n loan portfolios, <strong>in</strong> aggregate<br />
totall<strong>in</strong>g some A$50 billion to A$80 billion,<br />
to other counterparties or reduc<strong>in</strong>g<br />
fund<strong>in</strong>g l<strong>in</strong>es. At the time of publication,<br />
reports were emerg<strong>in</strong>g of the first of<br />
such activity, with a major foreign bank<br />
offer<strong>in</strong>g a portfolio of leveraged loans<br />
of up to A$100 million.<br />
In response to the feared pullout of foreign<br />
banks, <strong>in</strong> January <strong>2009</strong> the <strong>Australia</strong>n<br />
government launched a A$4 billion fund to<br />
support commercial property development<br />
projects that lose their <strong>in</strong>ternational<br />
f<strong>in</strong>ancial back<strong>in</strong>g due to the f<strong>in</strong>ancial<br />
crisis. Domestic banks will provide half<br />
the fund’s capital.<br />
Many second tier banks and other<br />
smaller f<strong>in</strong>ancial organisations are<br />
seek<strong>in</strong>g consolidation or other forms<br />
of partnership with larger <strong>in</strong>stitutions.<br />
Non-bank f<strong>in</strong>ancial <strong>in</strong>stitutions have been<br />
significantly weakened by the <strong>in</strong>crease <strong>in</strong><br />
the cost of fund<strong>in</strong>g, as well as the collapse<br />
<strong>in</strong> demand for hous<strong>in</strong>g f<strong>in</strong>ance with the<br />
fall <strong>in</strong> house prices.<br />
Each of these issues creates new<br />
pressures on <strong>Australia</strong>’s f<strong>in</strong>ancial system<br />
whose most marked characteristic over<br />
the past decade has been swift growth<br />
and fast <strong>in</strong>novation.<br />
<strong>Distressed</strong> assets<br />
A significant volume of distressed debt<br />
is an unfamiliar problem for <strong>Australia</strong>n<br />
lenders. <strong>Australia</strong>n f<strong>in</strong>ancial <strong>in</strong>stitutions<br />
have generally adopted a much simpler<br />
bus<strong>in</strong>ess model than their counterparts<br />
offshore. While banks and other f<strong>in</strong>anciers<br />
<strong>in</strong> the US, Europe and Asia have actively<br />
managed their balance sheets by sell<strong>in</strong>g<br />
<strong>in</strong>dividual loans or portfolios of nonperform<strong>in</strong>g<br />
loans (NPLs) and other<br />
distressed assets to realise value and<br />
transfer them off their books, <strong>Australia</strong>n<br />
banks have not done so, resolutely<br />
keep<strong>in</strong>g bad loans on their own books and<br />
focus<strong>in</strong>g on work<strong>in</strong>g them out themselves.
The full impact of Basel II is really unknown<br />
as yet as we have not lived through a cycle<br />
with it. If the full impact is applied, then there<br />
is no way banks can afford to carry NPLs on<br />
the balance sheets dur<strong>in</strong>g the tough times.<br />
Senior manager, major <strong>Australia</strong>n bank<br />
<strong>Australia</strong>n bankers, when <strong>in</strong>terviewed about the lack of a local<br />
market for distressed assets cite several reasons, the most<br />
persistent of which is that there has been no real need for one.<br />
“<strong>Australia</strong>n banks have never really thought about debt sales,”<br />
said one senior manager at a major <strong>Australia</strong>n bank. “There may<br />
be a number of reasons for this. It may be that the structure of<br />
<strong>Australia</strong>n loans – the documentation – has precluded trad<strong>in</strong>g<br />
them. Secondly, banks may have had the view that they would<br />
be forego<strong>in</strong>g too much profit were they to transfer their assets.<br />
And thirdly, because of their position <strong>in</strong> the community, banks<br />
would be reluctant to hand their customers over to a distressed<br />
asset firm that may not have the same relationship imperative.”<br />
Other reasons given <strong>in</strong>clude a cultural reluctance to admit<br />
mistakes, as well as a focus on workouts as a core bank<strong>in</strong>g<br />
competence that precludes the sale of NPLs.<br />
None of these reasons would seem strong enough to dissuade<br />
banks from enter<strong>in</strong>g <strong>in</strong>to an active distressed debt market if the<br />
volume of NPLs reached critical mass. As workout desks become<br />
<strong>in</strong>creas<strong>in</strong>gly overwhelmed, as <strong>in</strong>vestors beg<strong>in</strong> to offer prices that<br />
reflect the fair value of the loans, banks will be forced to consider<br />
the alternative to keep<strong>in</strong>g all NPLs on their balance sheets.<br />
Capital questions<br />
Over and above the pressure banks are likely to feel from<br />
<strong>in</strong>creas<strong>in</strong>g volumes of distressed assets, regulators will have a<br />
keen eye on banks’ management of capital. The <strong>in</strong>troduction of<br />
the Basel II regulations this year will <strong>in</strong>crease scrut<strong>in</strong>y of banks’<br />
NPL portfolios. There is grow<strong>in</strong>g concern among the bank<strong>in</strong>g<br />
community that both the banks and the regulators do not<br />
yet appreciate the full impact of the new regulations as levels<br />
of NPLs <strong>in</strong>crease significantly.<br />
Basel II requires banks to set aside up to 25% of the gross<br />
loan value of NPLs as Tier 1 Capital, capital that could be freed<br />
up to generate <strong>in</strong>come for the bank <strong>in</strong> other ways if the NPLs<br />
were sold to another party.<br />
Accord<strong>in</strong>g to one senior banker: “If the full impact of Basel II<br />
is applied, there is no way banks can afford to carry NPLs on<br />
their balance sheets dur<strong>in</strong>g the tough times.” He po<strong>in</strong>ts out<br />
that the Basel II regulations, if fully imposed, are extremely<br />
pro‐cyclical, discourag<strong>in</strong>g banks from lend<strong>in</strong>g dur<strong>in</strong>g<br />
downturns, and free<strong>in</strong>g up capital dur<strong>in</strong>g boom times.<br />
“We see a market wait<strong>in</strong>g<br />
to come to life.”<br />
Michael Sloan, Blake Dawson
<strong>Distressed</strong> corporates<br />
The distressed market is not just<br />
conf<strong>in</strong>ed to the impaired loans of<br />
<strong>Australia</strong>n banks. Many listed and private<br />
<strong>Australia</strong>n companies and trusts are<br />
experienc<strong>in</strong>g severe liquidity problems<br />
associated with loom<strong>in</strong>g ref<strong>in</strong>anc<strong>in</strong>g dates<br />
and a lack of replacement debt capital.<br />
To date, some larger listed corporates<br />
have managed to reduce gear<strong>in</strong>g and raise<br />
liquidity through cut price rais<strong>in</strong>gs on the<br />
equity market which, whilst dilutive, is a<br />
better option than the other alternatives.<br />
However, for private companies and listed<br />
companies with weak share prices, this<br />
option is generally not available. A number<br />
of off-shore and domestic funds and<br />
lenders are now target<strong>in</strong>g distressed<br />
corporates and offer<strong>in</strong>g them relatively<br />
highly priced debt (usually with a right to<br />
convert to equity upon agreed terms) to<br />
fund liquidity gaps. Such funds will also<br />
consider <strong>in</strong>vest<strong>in</strong>g equity but will seek<br />
assurances around the balance sheet<br />
and matters such as class action risk.<br />
Demand for distress<br />
Banks are <strong>in</strong>deed likely to consider sell<strong>in</strong>g<br />
their distressed assets <strong>in</strong> the near future.<br />
At the same time, there is significant<br />
demand for them from both global players<br />
based <strong>in</strong> Asia and local private equity<br />
players look<strong>in</strong>g to deploy their funds <strong>in</strong><br />
the distressed asset arena. The market <strong>in</strong><br />
Asia has been active s<strong>in</strong>ce the late 1990s,<br />
when the number of distressed companies<br />
shot up <strong>in</strong> the Asian f<strong>in</strong>ancial crisis. Across<br />
the globe, there are hundreds of entities<br />
that <strong>in</strong>vest <strong>in</strong> distressed assets, from<br />
the major <strong>in</strong>ternational players out of the<br />
US, such as Cerberus and Lonestar, to<br />
smaller specialist funds, many of which<br />
have pan-Asian funds that would consider<br />
<strong>Australia</strong> and New Zealand part of<br />
their <strong>in</strong>vestment universe.<br />
A survey of 100 hedge funds across Asia<br />
by Debtwire <strong>in</strong> October 2008 found that,<br />
after Ch<strong>in</strong>a and Indonesia, <strong>Australia</strong> is<br />
the market where most distressed debt<br />
opportunities are expected to arise over the<br />
com<strong>in</strong>g year. At the same time, <strong>Australia</strong>’s<br />
strong legal framework and regulatory<br />
environment give potential distressed asset<br />
<strong>in</strong>vestors security <strong>in</strong> their property rights,<br />
an advantage over the less predictable<br />
Ch<strong>in</strong>ese and Indonesian markets.<br />
“There are a number of th<strong>in</strong>gs we like<br />
about <strong>Australia</strong>,” says one manager at<br />
an <strong>in</strong>ternational alternative <strong>in</strong>vestment<br />
fund. “Firstly as a global fund we like<br />
the language, the law and the corporate<br />
governance framework. At the same<br />
time, because we deal with distressed<br />
assets we can see there are some real<br />
problems brew<strong>in</strong>g <strong>in</strong> the underly<strong>in</strong>g<br />
economy – so we are likely to see<br />
some opportunities arise there.”<br />
“The country also has a greater level<br />
of sophistication <strong>in</strong> terms of asset<br />
management networks. We are a capital<br />
provider, and can’t service <strong>in</strong>dividual loans<br />
from a pool of them. Rather, we need to<br />
tap <strong>in</strong>to an exist<strong>in</strong>g <strong>in</strong>frastructure to help<br />
us manage our assets, and that exists <strong>in</strong><br />
<strong>Australia</strong>, whereas it doesn’t <strong>in</strong> some of<br />
the less developed markets <strong>in</strong> Asia.”<br />
A po<strong>in</strong>t made by many asset managers<br />
was that, because many funds operate<br />
on a global basis, any <strong>in</strong>vestments <strong>in</strong><br />
<strong>Australia</strong> would have to offer risk-adjusted<br />
rates that were competitive with those<br />
10
There are a number of th<strong>in</strong>gs we like about<br />
<strong>Australia</strong>. Firstly as a global fund we like the<br />
language, the law and the corporate governance<br />
framework. At the same time, because we deal<br />
with distressed assets we can see there are<br />
some real problems brew<strong>in</strong>g <strong>in</strong> the underly<strong>in</strong>g<br />
economy – so we are likely to see some<br />
opportunities arise there.<br />
Manager, <strong>in</strong>ternational alternative <strong>in</strong>vestment fund<br />
atta<strong>in</strong>ed <strong>in</strong> other parts of the world. At the<br />
moment, there is an impression that there<br />
is someth<strong>in</strong>g of a large spread between<br />
what sellers of distressed debt might<br />
offer, and what buyers might pay.<br />
“My feel<strong>in</strong>g,” says another distressed<br />
asset specialist operat<strong>in</strong>g across Asia,<br />
“is that the market <strong>in</strong> <strong>Australia</strong> is still <strong>in</strong><br />
price discovery mode. There is a fairly<br />
large bid-ask differential.”<br />
At the same time, asset prices across<br />
the globe have been fall<strong>in</strong>g steadily s<strong>in</strong>ce<br />
mid-2008, and many <strong>in</strong>vestors are sitt<strong>in</strong>g<br />
on the sidel<strong>in</strong>es wait<strong>in</strong>g to see when<br />
a bottom might be found.<br />
The picture is one of a market wait<strong>in</strong>g to<br />
come to life. On the supply side sit the<br />
banks, with a grow<strong>in</strong>g pool of distressed<br />
assets that will need to be managed for<br />
value, but constra<strong>in</strong>ed <strong>in</strong> their ability to<br />
expand workout operations by supply of<br />
experience. They are also limited <strong>in</strong> their<br />
capacity to hold NPLs by the need to set<br />
aside significant amounts of regulatory<br />
capital aga<strong>in</strong>st them. On the demand side,<br />
there are a large number of funds with<br />
considerable amounts of capital available<br />
ready and will<strong>in</strong>g to <strong>in</strong>vest <strong>in</strong> these assets.<br />
With a change <strong>in</strong> approach from <strong>Australia</strong>’s<br />
major banks, an adjustment <strong>in</strong> price<br />
expectations from both sellers and buyers,<br />
and a detailed understand<strong>in</strong>g of the legal<br />
and bus<strong>in</strong>ess issues discussed <strong>in</strong> the<br />
rest of this publication, we anticipate the<br />
creation and growth of a real market for<br />
distressed <strong>in</strong>vest<strong>in</strong>g <strong>in</strong> <strong>Australia</strong> over the<br />
next few years. This growth will benefit<br />
banks, <strong>in</strong>vestment funds, and, <strong>in</strong> the end,<br />
companies experienc<strong>in</strong>g f<strong>in</strong>ancial distress<br />
to have an efficient market focused on the<br />
ownership and management of their debt.<br />
11
1. The who, the how<br />
and the why of<br />
buy<strong>in</strong>g distressed<br />
debt/assets<br />
The distressed debt market <strong>in</strong> Asia matured dur<strong>in</strong>g the late<br />
1990s as numerous countries <strong>in</strong> the region went through a<br />
period of economic turmoil. The Asian f<strong>in</strong>ancial crisis threw<br />
up many “distressed opportunities” offer<strong>in</strong>g alternative<br />
<strong>in</strong>vestors above average returns. These opportunities,<br />
comb<strong>in</strong>ed with a flatten<strong>in</strong>g of returns <strong>in</strong> the US/Lat<strong>in</strong><br />
American distressed markets focused <strong>in</strong>vestors’<br />
attention on the Asian markets.<br />
The <strong>in</strong>itial <strong>in</strong>flux of buyers came primarily<br />
out of the US and <strong>in</strong>cluded larger players/<br />
funds such as Cerberus and Lonestar,<br />
and f<strong>in</strong>ance houses such as GE. Target<br />
acquisitions <strong>in</strong>cluded large secured NPL<br />
portfolios, real estate and large corporate<br />
debt. As the economic crisis worsened<br />
more opportunities arose across Asia and<br />
especially <strong>in</strong> countries such as Taiwan,<br />
Japan, Korea, Thailand, Philipp<strong>in</strong>es,<br />
India, Ch<strong>in</strong>a and Malaysia. With early<br />
deals reportedly generat<strong>in</strong>g significant<br />
returns, the market for distressed<br />
debt quickly grew and the number<br />
of “players” expanded exponentially.<br />
While statistics vary, <strong>in</strong> today’s market<br />
there is estimated to be hundreds<br />
of <strong>in</strong>vestors <strong>in</strong>volved <strong>in</strong> the distressed<br />
debt market. The major distressed debt<br />
<strong>in</strong>vestors have been around s<strong>in</strong>ce the<br />
early 1980s and have developed unique<br />
skills and expertise <strong>in</strong> valu<strong>in</strong>g, buy<strong>in</strong>g and<br />
manag<strong>in</strong>g distressed debt acquisitions.<br />
Initially the majority of distressed debt<br />
<strong>in</strong>vestors orig<strong>in</strong>ated <strong>in</strong> the US and<br />
Europe, but the growth of opportunities<br />
<strong>in</strong> Asian markets <strong>in</strong> the last 10 years<br />
has seen the emergence of numerous<br />
Asian-based buyers focus<strong>in</strong>g solely<br />
on Asian opportunities.<br />
The current global economic turmoil has<br />
seen a number of funds pull out of the<br />
market and others take a very cautious<br />
approach to <strong>in</strong>vest<strong>in</strong>g. To quote a common<br />
phrase, no one wants to catch a fall<strong>in</strong>g<br />
knife. Our discussions with <strong>in</strong>vestors<br />
have <strong>in</strong>dicated that while this was the<br />
general consensus <strong>in</strong> 2008, most expect<br />
to revisit these views <strong>in</strong> <strong>2009</strong>. Also it<br />
would seem that established buyers are<br />
look<strong>in</strong>g to raise new funds and capitalise<br />
on the movement of capital away from<br />
traditional areas to distressed <strong>in</strong>vest<strong>in</strong>g.<br />
The chart on page 36 <strong>in</strong>dicates the extent<br />
of rais<strong>in</strong>gs by distressed funds over the<br />
past couple of years.<br />
A unique characteristic of the current<br />
economic turmoil is the true global nature<br />
of the downturn. Previous downturns have<br />
focused on particular regions and hence<br />
distressed <strong>in</strong>vestors focused on particular<br />
markets. An issue for Asia Pacific sellers<br />
is that due to the state of markets <strong>in</strong> the<br />
US and Europe, the big global distressed<br />
<strong>in</strong>vestors who work with a global pool of<br />
capital will focus their attention wherever<br />
the best returns can be achieved.<br />
Currently this is <strong>in</strong> Europe and the US.<br />
For the market <strong>in</strong> distressed debt to grow<br />
<strong>in</strong> <strong>Australia</strong>, pric<strong>in</strong>g and returns will have<br />
to be comparable with global valuations.<br />
12
Established buyers are look<strong>in</strong>g to<br />
raise new funds and capitalise on<br />
the movement of capital away from<br />
traditional areas to distressed <strong>in</strong>vest<strong>in</strong>g.<br />
How are <strong>in</strong>vestors classified?<br />
<strong>Distressed</strong> <strong>in</strong>vestors can generally be classified<br />
<strong>in</strong>to the follow<strong>in</strong>g three categories:<br />
1. <strong>Distressed</strong> debt funds<br />
(Hedge funds, private equity funds)<br />
This category is made up of those buyers that have a<br />
primary focus on distressed debt or assets. Many of<br />
the early players <strong>in</strong> the distressed market were funds<br />
established by ex-<strong>in</strong>vestment bankers with wealthy<br />
clientele look<strong>in</strong>g for above average returns. Historically<br />
these funds have been subject to m<strong>in</strong>imal regulatory<br />
control and have therefore been able to preserve high<br />
levels of confidentiality. In Asia at present there is a<br />
large number of these types of funds rang<strong>in</strong>g <strong>in</strong> size<br />
from the small with more than US$50 million to <strong>in</strong>vest<br />
to the large with over US$1 billion available to <strong>in</strong>vest.<br />
In the current climate these funds are typically look<strong>in</strong>g<br />
for opportunities where they can br<strong>in</strong>g to bear their<br />
f<strong>in</strong>ancial skills, such as restructur<strong>in</strong>g a company to<br />
maximise their returns. Typical <strong>in</strong>vestment size across<br />
Asia is US$10 to 25 million while some of the larger<br />
funds will look at US$100 million plus opportunities.<br />
Return requirements are generally <strong>in</strong> the 25% plus<br />
Internal Rate of Return (IRR) range. While usually<br />
distressed funds prefer to <strong>in</strong>vest on their own rather<br />
than <strong>in</strong> a jo<strong>in</strong>t venture structure, <strong>in</strong> the current climate<br />
structur<strong>in</strong>g deals <strong>in</strong>clud<strong>in</strong>g jo<strong>in</strong>t ventures are becom<strong>in</strong>g<br />
more popular as a means to mitigate exposure and<br />
enhance value to both the buyer and the seller.<br />
New entrants <strong>in</strong>to the market have been the<br />
traditional Private Equity firms. As the number of<br />
traditional private equity deals have slowed or the<br />
risks and rewards have become relatively unattractive,<br />
alternative forms of <strong>in</strong>vestment are be<strong>in</strong>g <strong>in</strong>vestigated.<br />
Traditionally private equity has purchased equity as<br />
a means to assume control; however the distressed<br />
<strong>in</strong>vest<strong>in</strong>g model of us<strong>in</strong>g the debt structure to secure<br />
control with added security is becom<strong>in</strong>g <strong>in</strong>creas<strong>in</strong>gly<br />
attractive for those funds that still have cash.<br />
The majority of these funds are offshore, but a number<br />
of new funds are sett<strong>in</strong>g up <strong>in</strong> <strong>Australia</strong>.<br />
2. F<strong>in</strong>ancial <strong>in</strong>stitutions<br />
(<strong>in</strong>clud<strong>in</strong>g <strong>in</strong>vestment banks,<br />
commercial banks and f<strong>in</strong>ancial houses)<br />
Many f<strong>in</strong>ancial <strong>in</strong>stitutions have “special situation<br />
groups” focus<strong>in</strong>g on distressed debt <strong>in</strong>vest<strong>in</strong>g.<br />
Typically these operations form part of the bank<br />
and often focus both <strong>in</strong>ternally and externally.<br />
For example, a special situations group can help their<br />
parent <strong>in</strong>stitution with their own non‐perform<strong>in</strong>g loans,<br />
can help expand customer bases by purchas<strong>in</strong>g nonperform<strong>in</strong>g<br />
loans from other f<strong>in</strong>ancial <strong>in</strong>stitutions or<br />
can <strong>in</strong>vest their own funds.<br />
Some of the more consistent <strong>in</strong>vestors here <strong>in</strong>clude<br />
Morgan Stanley, JP Morgan, UBS, Goldman Sachs,<br />
Merrill Lynch, Standard Chartered, Standard Bank,<br />
Deutsche Bank, HSBC, Citibank and GE.<br />
These <strong>in</strong>vestors tend to have higher <strong>in</strong>vestment size<br />
preferences <strong>in</strong> the range of US$15 to 20 million plus.<br />
3. Local buyers<br />
Both categories 1. and 2. are generally foreign<br />
<strong>in</strong>vestors, as typically their focus is cross border,<br />
i.e. they will look to <strong>in</strong>vest <strong>in</strong> multiple countries<br />
with<strong>in</strong> a region.<br />
Given the growth <strong>in</strong> distressed debt opportunities<br />
<strong>in</strong> Asia over the last 10 years, a number of “local<br />
operators” have been established to focus on specific<br />
country based opportunities. A good example of<br />
these are government supported entities established<br />
to resolve local bank non-perform<strong>in</strong>g loan problems<br />
such as the Asset Management Companies (AMCs)<br />
established <strong>in</strong> Ch<strong>in</strong>a, Thailand, India and Vietnam.<br />
In <strong>Australia</strong> a number of local servic<strong>in</strong>g companies<br />
have also looked to purchase NPLs ma<strong>in</strong>ly focused<br />
on the consumer credit card space and generally<br />
on a forward flow basis.<br />
13
Countries rated on their distressed debt opportunities <strong>in</strong> <strong>2009</strong><br />
Ch<strong>in</strong>a 65<br />
17<br />
8 4 4<br />
Indonesia 49<br />
23<br />
15<br />
11 2<br />
<strong>Australia</strong> 38<br />
22<br />
22<br />
16<br />
2<br />
South Korea 36<br />
16<br />
31<br />
13<br />
4<br />
India 25<br />
25<br />
29<br />
17<br />
4<br />
Thailand 16<br />
27<br />
36<br />
16<br />
5<br />
Vietnam 21<br />
18<br />
41<br />
15<br />
5<br />
Philipp<strong>in</strong>es 17<br />
24<br />
37<br />
17<br />
5<br />
Japan 12 21<br />
43<br />
19<br />
5<br />
Malaysia 14<br />
17<br />
43<br />
19<br />
7<br />
Taiwan 9 21<br />
47<br />
18<br />
5<br />
Hong Kong 12 20<br />
32<br />
34<br />
2<br />
New Zealand 3 14<br />
54<br />
26<br />
3<br />
S<strong>in</strong>gapore 8 13<br />
36<br />
28<br />
15<br />
0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%<br />
Percentage of respondents<br />
Significant Very High High Low None<br />
Source Debtwire: Asia-Pacific <strong>Distressed</strong> Debt Outlook <strong>2009</strong>, December 2008. Survey canvassed 100 hedge fund<br />
managers and proprietary trad<strong>in</strong>g bankers.<br />
Investors focus on <strong>Australia</strong><br />
The attractiveness of the <strong>Australia</strong>n market<br />
to distressed <strong>in</strong>vestors is highlighted by the<br />
chart above – 60% of the 100 <strong>in</strong>vestors<br />
surveyed throughout Asia had “significant”<br />
or “very high” potential for distressed debt<br />
opportunities <strong>in</strong> <strong>2009</strong>. The same survey<br />
found Ch<strong>in</strong>a and Indonesia (the only two<br />
countries rated more highly for distressed<br />
opportunities than <strong>Australia</strong>) to be the<br />
countries where it is most difficult for<br />
creditors to exercise or enforce their rights<br />
over security or to enforce their rights <strong>in</strong><br />
court. As a result, <strong>Australia</strong> is very much<br />
on <strong>in</strong>vestors’ radars.<br />
The added attraction of the <strong>Australia</strong>n<br />
market is the strength of the regulatory,<br />
legal and governance environments.<br />
As one <strong>in</strong>vestor mentioned, “when we<br />
walk <strong>in</strong>to an <strong>Australia</strong>n court the chances<br />
of us gett<strong>in</strong>g subjugated to a lower asset<br />
class is pretty unlikely.” In comparison to<br />
other Asian markets, <strong>Australia</strong>’s strong<br />
legal and regulatory framework provides<br />
a relatively high level of comfort and<br />
security for <strong>in</strong>vestors.<br />
Types of <strong>in</strong>vestments<br />
Deal types<br />
Most distressed debt <strong>in</strong>vestors<br />
will look at a range of deal types<br />
<strong>in</strong>clud<strong>in</strong>g the follow<strong>in</strong>g:<br />
• NPL portfolios sold by banks (either<br />
secured or unsecured, although secured<br />
portfolios tend to attract more <strong>in</strong>terest)<br />
• High yield lend<strong>in</strong>g<br />
• Equity <strong>in</strong>vestments, often coupled<br />
with high yield lend<strong>in</strong>g, particularly<br />
<strong>in</strong> the real estate sector<br />
• Equity <strong>in</strong>vestments and/or high<br />
yield lend<strong>in</strong>g, <strong>in</strong> private companies<br />
or State Owned Enterprises (SOEs)<br />
often comb<strong>in</strong>ed with management<br />
<strong>in</strong>fluence (e.g. seats on the board)<br />
• <strong>Distressed</strong> real estate or real estate<br />
seized by f<strong>in</strong>ancial <strong>in</strong>stitutions and<br />
subsequently offered for sale<br />
• S<strong>in</strong>gle credits of distressed debtors<br />
• Credit card portfolios or other<br />
types of “receivable” portfolios<br />
(such as utility debts)<br />
• NPLs or NPL portfolios on<br />
the secondary market.<br />
14
Assessment approaches<br />
While each of the above <strong>in</strong>vestment<br />
types will require a different “assessment”<br />
approach, typically <strong>in</strong>vestors will consider<br />
the follow<strong>in</strong>g issues <strong>in</strong> relation to each<br />
potential transaction:<br />
• Determ<strong>in</strong><strong>in</strong>g an exit strategy<br />
– depend<strong>in</strong>g on the nature of the<br />
<strong>in</strong>vestment, exit strategies may<br />
range from regular debt repayments,<br />
foreclosure actions, sale of assets or<br />
realisation of equity hold<strong>in</strong>gs<br />
• Estimat<strong>in</strong>g future cashflow – what are<br />
the tim<strong>in</strong>gs and total expected gross<br />
cashflow amounts generated by the<br />
proposed exit strategy, for example<br />
the tim<strong>in</strong>g and amount of forecast debt<br />
repayments or the realisation of assets<br />
• Estimat<strong>in</strong>g costs to be <strong>in</strong>curred<br />
<strong>in</strong> relation to the adopted exit strategy<br />
such as outsourced collection costs or<br />
the cost of establish<strong>in</strong>g a local presence<br />
• Agree<strong>in</strong>g on the desired required return<br />
factor<strong>in</strong>g <strong>in</strong> the cost of debt/equity and<br />
estimated risk to the <strong>in</strong>vestment.<br />
Key elements<br />
While each <strong>in</strong>vestor has a specific<br />
“<strong>in</strong>vestment decision matrix” and<br />
a “preferred <strong>in</strong>vestment type”, the<br />
key elements that they all look for<br />
<strong>in</strong> any transaction <strong>in</strong>clude:<br />
• Reasonable transaction size relative to<br />
the fund size, i.e. the effort to be put<br />
<strong>in</strong>to a deal needs to be justified through<br />
a mean<strong>in</strong>gful <strong>in</strong>vestment amount.<br />
Typically the average <strong>in</strong>vestor is look<strong>in</strong>g<br />
at deal sizes (across Asia) of between<br />
US$10 to 25 million with larger <strong>in</strong>vestors<br />
look<strong>in</strong>g to allocate up US$100 million<br />
on a deal by deal basis<br />
• Access to reliable and current data with<br />
which to make the <strong>in</strong>vestment decision<br />
• Certa<strong>in</strong>ty of a transaction tak<strong>in</strong>g place,<br />
especially <strong>in</strong> the case of a NPL sale<br />
by a bank<br />
• A clear exit strategy <strong>in</strong>clud<strong>in</strong>g a relatively<br />
predictable timeframe. In this regard<br />
some <strong>in</strong>vestors look for a relatively short<br />
turn around such as less than 1 year<br />
while others prefer longer timeframes.<br />
It is not uncommon for distressed debt<br />
<strong>in</strong>vestments to have an average life<br />
of 2 to 4 years<br />
• Above average return requirements –<br />
while return requirements vary between<br />
<strong>in</strong>vestors and for each <strong>in</strong>vestment type,<br />
all distressed <strong>in</strong>vestors are look<strong>in</strong>g<br />
for above average returns.<br />
15
Secondary debt trad<strong>in</strong>g terms<br />
Traded distressed debt <strong>in</strong>cludes secured and<br />
unsecured bank debt, trade debts, liquidated<br />
and unliquidated damages claims and other<br />
choses <strong>in</strong> action.<br />
The transfer of economic risk associated with a debt<br />
may be achieved either by transferr<strong>in</strong>g the debt itself<br />
so that the purchaser of the debt enters <strong>in</strong>to a direct<br />
relationship with the debtor or by sub-participation<br />
of the debt <strong>in</strong> which case the purchaser assumes<br />
the economic risk associated with the debt pursuant<br />
to a contractual relationship with the seller only.<br />
Debt transfers are normally carried out by legal<br />
novation or assignment and the mechanism for<br />
transfer is likely to be set out <strong>in</strong> the relevant loan<br />
documentation. Any such transfer must be carried<br />
out <strong>in</strong> accordance with the terms of the loan<br />
documentation which may <strong>in</strong>clude restrictions on<br />
the m<strong>in</strong>imum amount of debt that can be transferred<br />
or the nature of transferees. For <strong>in</strong>stance, it is<br />
common for loan agreements to <strong>in</strong>clude provisions<br />
provid<strong>in</strong>g that the debt may only be transferred<br />
to another f<strong>in</strong>ancial <strong>in</strong>stitution.<br />
Sub-participation is more flexible because the<br />
debtor is not party to the arrangement and<br />
has no <strong>in</strong>fluence on the terms. For this reason,<br />
portfolio sales are likely to be carried out by<br />
sub-participation. Sub-participations can be funded<br />
(the purchaser makes payment upfront) or unfunded<br />
(the purchaser <strong>in</strong>demnifies the vendor <strong>in</strong> the<br />
event of a payment default).<br />
A funded sub-participant assumes a credit risk<br />
on the seller whereas <strong>in</strong> the case of an unfunded<br />
sub-participation the seller assumes a credit risk<br />
on the purchaser.<br />
Sub-participants are also exposed to <strong>in</strong>creased<br />
cost risk and withhold<strong>in</strong>g tax risk as they do not<br />
receive the benefit of the protections under the loan<br />
agreement. Similarly a sub-participant will not be able<br />
to access market disruption provisions.<br />
Where only part of a particular debt is sub-participated<br />
a key issue will be how vot<strong>in</strong>g rights under the relevant<br />
loan are executed. Generally, the lender of record<br />
will not be able to split its vote so vot<strong>in</strong>g rights will<br />
generally go to the <strong>in</strong>stitution with the largest exposure<br />
subject to consultation. However, <strong>in</strong> some <strong>in</strong>stances<br />
where the lender of record is keen to protect a client<br />
relationship it may be reluctant to cede vot<strong>in</strong>g control<br />
even to a sub-participant of the majority of its debt.<br />
Other important considerations <strong>in</strong> distressed debt<br />
trades are whether the sub-participant has the ability<br />
to force a transfer of the debt to it and whether it<br />
receives an <strong>in</strong>terest <strong>in</strong> ancillary rights to the debt<br />
(e.g. claims aga<strong>in</strong>st advisors <strong>in</strong> respect of reports<br />
provided to the vendor).<br />
In distressed debt trad<strong>in</strong>g a central issue of focus is<br />
whether the purchaser is tak<strong>in</strong>g the risk only on the<br />
level of return or on the risk of the validity of the claim.<br />
Often the vendor will reta<strong>in</strong> the risk that the claim<br />
is rejected by a liquidator.<br />
The Asian secondary debt markets (<strong>in</strong>clud<strong>in</strong>g<br />
<strong>Australia</strong>) have not yet developed their own<br />
standard documentation or terms for distressed<br />
debt trad<strong>in</strong>g, but the Asia Pacific Loan Markets<br />
Association is seek<strong>in</strong>g to progress standardised<br />
documentation for <strong>Australia</strong>. For most trades with<strong>in</strong><br />
these markets, parties typically adapt local par debt<br />
trad<strong>in</strong>g documents us<strong>in</strong>g distressed debt terms<br />
from the US market (Loan Syndication and Trad<strong>in</strong>g<br />
Association (LSTA) terms) or the European market<br />
(the Loan Market<strong>in</strong>g Association (LMA) distressed<br />
debt trad<strong>in</strong>g terms). Standard documentation<br />
available <strong>in</strong>cludes risk transfer documentation and<br />
associated documents for carry<strong>in</strong>g out a debt<br />
trade such as confidentiality arrangements.<br />
16
Perspective<br />
• The unique characteristic of the current economic turmoil is the global<br />
nature of the downturn. Major global distressed <strong>in</strong>vestors will focus<br />
their attention wherever the best returns can be achieved. <strong>Australia</strong>’s<br />
advantage is the strength of our regulatory, legal and governance<br />
environments, which offer security for <strong>in</strong>vestors.<br />
• Sellers of distressed debt need to know about likely buyers (who<br />
generally fall <strong>in</strong>to three ma<strong>in</strong> categories: foreign distressed debt<br />
funds, foreign f<strong>in</strong>ancial <strong>in</strong>stitutions and local buyers), their return<br />
requirements, their preferred <strong>in</strong>vestment types and approaches,<br />
how they make their <strong>in</strong>vestment decisions and the key elements<br />
of what they look for <strong>in</strong> a transaction.<br />
• Important considerations for both buyers and sellers are the<br />
secondary debt trad<strong>in</strong>g terms and the transfer of economic<br />
risk associated with a debt. Any transfer must be carried out<br />
with the terms of the relevant loan documentation.<br />
• The Asia Pacific Loan Markets Association is seek<strong>in</strong>g to<br />
progress standardised documentation or terms for distressed<br />
debt trad<strong>in</strong>g for <strong>Australia</strong>. Currently parties typically adapt local<br />
debt trad<strong>in</strong>g documents from the US or the European standard<br />
terms. Standard documentation available <strong>in</strong>cludes risk transfer<br />
documentation and associated documents for carry<strong>in</strong>g out a<br />
debt trade such as confidentiality arrangements.<br />
In comparison to other Asian markets,<br />
<strong>Australia</strong>’s strong legal and regulatory<br />
framework provides a relatively high level<br />
of comfort and security for <strong>in</strong>vestors.<br />
17
2. Portfolio debt sales –<br />
the key considerations<br />
<strong>in</strong> value<br />
There are many <strong>in</strong>terlock<strong>in</strong>g factors that will determ<strong>in</strong>e<br />
the value for the transfer of a loan portfolio.<br />
The factors that will impact pric<strong>in</strong>g <strong>in</strong>clude:<br />
• The credit approval process<br />
• The quality of the portfolio<br />
• The type of sale<br />
• The quality of <strong>in</strong>formation<br />
• The tim<strong>in</strong>g of the sale.<br />
The risks posed by each of these factors<br />
can be m<strong>in</strong>imised by ensur<strong>in</strong>g a robust<br />
and transparent process.<br />
The ma<strong>in</strong> variables that will be considered<br />
by the buyers <strong>in</strong>clude the follow<strong>in</strong>g:<br />
• How much of the <strong>in</strong>dividual debt<br />
will be recovered?<br />
• How long will it take to collect?<br />
• How much will it cost to collect?<br />
• What is the risk associated with the<br />
debt recovery process?<br />
The key considerations are summarised<br />
<strong>in</strong> the diagram below.<br />
How much of the <strong>in</strong>dividual<br />
debt will be recovered?<br />
The key determ<strong>in</strong>ant of value will be<br />
the proportion of the outstand<strong>in</strong>g debt<br />
that can be realistically recovered<br />
from the borrower.<br />
Corporate loans<br />
For corporate loans the first question<br />
is whether or not the loan is secured,<br />
and if so, what is the realisable value<br />
of the underly<strong>in</strong>g security. The key issue<br />
here is how current is the appraisal.<br />
Once a floor has been set on the loan<br />
value the next question to be addressed<br />
is whether the borrower is likely to seek<br />
to restructure the loan. Issues that need<br />
to be taken <strong>in</strong> to account <strong>in</strong>clude:<br />
• Are there personal guarantees?<br />
• Are there director liability issues?<br />
• Who has provided the guarantees?<br />
• Is the company still trad<strong>in</strong>g?<br />
A buyer's key considerations<br />
How much<br />
will I collect<br />
and from<br />
what sources?<br />
When will<br />
I collect?<br />
Servic<strong>in</strong>g<br />
and<br />
Management<br />
Costs<br />
Discounted<br />
for return<br />
requirements<br />
(<strong>in</strong>corporat<strong>in</strong>g<br />
leverage)<br />
Valuation<br />
18
The emergence and cont<strong>in</strong>ued growth of a<br />
secondary market for distressed debts and<br />
assets is a sign of the <strong>in</strong>creas<strong>in</strong>g depth and<br />
sophistication of <strong>Australia</strong>n f<strong>in</strong>ancial markets.<br />
James Marshall, Blake Dawson<br />
Address<strong>in</strong>g each of these questions will<br />
assist <strong>in</strong> determ<strong>in</strong><strong>in</strong>g if a restructur<strong>in</strong>g<br />
or renegotiation of the debt will be<br />
possible. If a restructur<strong>in</strong>g or discounted<br />
pay out is not possible then how<br />
much of the loan over and above the<br />
security is recoverable? Some of the<br />
issues here <strong>in</strong>clude whether there are<br />
guarantees <strong>in</strong> place, what assets are<br />
beh<strong>in</strong>d the guarantors and where are<br />
the guarantors located?<br />
Consumer loans<br />
For consumer loans the questions<br />
are similar:<br />
• Are the loans secured, and if so,<br />
what is the realisable value of the<br />
underly<strong>in</strong>g security?<br />
• What are the chances of renegotiat<strong>in</strong>g<br />
the loans?<br />
• What are the chances of recover<strong>in</strong>g<br />
any of the shortfall after realis<strong>in</strong>g<br />
the security?<br />
• For unsecured loans what are the<br />
chances of recover<strong>in</strong>g any amount<br />
from the borrower?<br />
• What is the likely tim<strong>in</strong>g of any<br />
liquidation dividend?<br />
To determ<strong>in</strong>e the likelihood of recovery,<br />
borrower characteristics such as age,<br />
sex, location and employment status<br />
must be assessed. Other factors<br />
<strong>in</strong>fluenc<strong>in</strong>g recoverability will be the<br />
type of loan and what it was used for<br />
and what sort of recovery process has<br />
the loan been through?<br />
How long will it take to collect?<br />
Any purchaser of debt will factor <strong>in</strong> the<br />
time value of the <strong>in</strong>vestment, and discount<br />
the future payment stream back to present<br />
value. Assumptions regard<strong>in</strong>g the time<br />
it is likely to take to recover the debt will<br />
have significant <strong>in</strong>fluence on the overall<br />
valuation. There are a number of factors<br />
that will be key, <strong>in</strong>clud<strong>in</strong>g:<br />
• What restructur<strong>in</strong>g or discounted<br />
payoff is to be put <strong>in</strong> place,<br />
and over what period?<br />
• How long will it take to foreclose<br />
on a property?<br />
• What are the potential impediments<br />
to enforc<strong>in</strong>g security?<br />
• How long is the typical bankruptcy<br />
process for corporates or <strong>in</strong>dividuals?<br />
• How long does it take to sell assets?<br />
• How far through the recovery process<br />
is the seller?<br />
<strong>Australia</strong>n<br />
<strong>in</strong>solvency procedures<br />
The ma<strong>in</strong> steps <strong>in</strong> each of the major<br />
formal recovery procedures <strong>in</strong> <strong>Australia</strong><br />
are outl<strong>in</strong>ed below.<br />
Adm<strong>in</strong>istration<br />
Voluntary adm<strong>in</strong>istration is the most<br />
common formal corporate rescue process<br />
used <strong>in</strong> <strong>Australia</strong>. It is most often <strong>in</strong>itiated<br />
by the directors of the company because<br />
the appo<strong>in</strong>tment of an adm<strong>in</strong>istrator<br />
will relieve the directors from any risk<br />
of personal liability for <strong>in</strong>solvent trad<strong>in</strong>g<br />
<strong>in</strong> relation to debts <strong>in</strong>curred follow<strong>in</strong>g<br />
the appo<strong>in</strong>tment of an adm<strong>in</strong>istrator.<br />
An adm<strong>in</strong>istrator can be appo<strong>in</strong>ted by<br />
the directors (by resolution), a liquidator<br />
of the company, or the holder of a fully<br />
secured charge over the company.<br />
19
Adm<strong>in</strong>istrators are given wide powers<br />
to control and manage the company,<br />
and the directors are not permitted<br />
to exercise any powers except with<br />
the consent of the adm<strong>in</strong>istrator.<br />
The appo<strong>in</strong>tment of an adm<strong>in</strong>istrator gives<br />
an <strong>in</strong>dependent <strong>in</strong>solvency practitioner<br />
the power to adm<strong>in</strong>ister and conduct the<br />
company’s bus<strong>in</strong>ess. Adm<strong>in</strong>istrators are<br />
given wide powers to control and manage<br />
the company, and the directors are not<br />
permitted to exercise any powers except<br />
with the consent of the adm<strong>in</strong>istrator.<br />
The adm<strong>in</strong>istration process under<br />
<strong>Australia</strong>n law is driven by the votes of<br />
unsecured creditors at creditor meet<strong>in</strong>gs.<br />
Courts do not supervise the process<br />
but can adjudicate on issues that arise<br />
upon the application of <strong>in</strong>terested parties,<br />
<strong>in</strong>clud<strong>in</strong>g the adm<strong>in</strong>istrators. Whilst<br />
<strong>in</strong> adm<strong>in</strong>istration, statutory moratoria<br />
prevent proceed<strong>in</strong>gs aga<strong>in</strong>st the company<br />
be<strong>in</strong>g commenced, charges be<strong>in</strong>g<br />
enforced aga<strong>in</strong>st the company (subject<br />
to a 13 day decision period for holders<br />
of full security) or property be<strong>in</strong>g recovered<br />
from the possession of the company,<br />
except <strong>in</strong> certa<strong>in</strong> circumstances.<br />
However, there is no moratorium<br />
prevent<strong>in</strong>g contractors from term<strong>in</strong>at<strong>in</strong>g<br />
their contracts on the basis of an<br />
<strong>in</strong>solvency event clause. In many cases<br />
contracts will conta<strong>in</strong> default provisions<br />
which allow for term<strong>in</strong>ation upon the<br />
appo<strong>in</strong>tment of an adm<strong>in</strong>istrator.<br />
The adm<strong>in</strong>istrator must generally<br />
report to the creditors, <strong>in</strong> writ<strong>in</strong>g,<br />
with<strong>in</strong> 30 bus<strong>in</strong>ess days of appo<strong>in</strong>tment<br />
specify<strong>in</strong>g the options for the company’s<br />
future. The options are either a deed<br />
of company arrangement, liquidation<br />
or return of the company to the control<br />
of the directors. The report will conta<strong>in</strong><br />
the adm<strong>in</strong>istrator’s recommendation<br />
as to which option is <strong>in</strong> the<br />
creditors’ best <strong>in</strong>terests.<br />
20
The key steps and timel<strong>in</strong>es for voluntary adm<strong>in</strong>istration<br />
Action<br />
Notice of appo<strong>in</strong>tment sent to creditors<br />
First meet<strong>in</strong>g of creditors<br />
Second meet<strong>in</strong>g of creditors<br />
Adjournment of second meet<strong>in</strong>g of creditors<br />
Timeframe<br />
5 bus<strong>in</strong>ess days from appo<strong>in</strong>tment<br />
8 bus<strong>in</strong>ess days from appo<strong>in</strong>tment (omit the first day)<br />
Up to 30 bus<strong>in</strong>ess days from appo<strong>in</strong>tment<br />
Permitted for up to 45 bus<strong>in</strong>ess days with creditor approval;<br />
further extensions possible with court approval<br />
Given the extensions which may be made<br />
to the tim<strong>in</strong>g of the second meet<strong>in</strong>g of<br />
creditors, <strong>in</strong> complex adm<strong>in</strong>istrations<br />
it may take between 3 and 12 months<br />
before the company’s fate is voted upon.<br />
At the second meet<strong>in</strong>g of creditors, the<br />
creditors vote on whether the company<br />
should enter <strong>in</strong>to a deed of company<br />
arrangement, be liquidated, or returned to<br />
the control of the directors (a majority vote<br />
is counted <strong>in</strong> terms of numbers and value).<br />
Significantly, no court approval is required.<br />
If a deed of company arrangement<br />
is entered <strong>in</strong>to, the limited statutory<br />
requirements allow tremendous flexibility.<br />
Deeds can be used to implement almost<br />
whatever type of arrangement the situation<br />
requires – from a simple compromise of<br />
debts to a complete corporate restructure,<br />
a capital rais<strong>in</strong>g or a cont<strong>in</strong>uation of the<br />
bus<strong>in</strong>ess. Recent reforms have also<br />
enhanced this flexibility by facilitat<strong>in</strong>g<br />
post-restructur<strong>in</strong>g equity rais<strong>in</strong>g<br />
and debt f<strong>in</strong>anc<strong>in</strong>g.<br />
Where the creditors accept a proposal<br />
that the company is to cont<strong>in</strong>ue to trade,<br />
the execution of the deed of company<br />
arrangement marks the end of the<br />
adm<strong>in</strong>istration. The terms of the deed<br />
replace the statutory moratorium on<br />
company debts and the arrangement<br />
b<strong>in</strong>ds all of the company’s creditors,<br />
shareholders, directors, the company<br />
and the deed adm<strong>in</strong>istrator.<br />
Adm<strong>in</strong>istration and<br />
Chapter 11 compared<br />
Overseas <strong>in</strong>vestors are often <strong>in</strong>terested<br />
to compare <strong>Australia</strong>’s voluntary<br />
adm<strong>in</strong>istration regime with the<br />
United States’ Chapter 11 procedure.<br />
The table on page 22 highlights the key<br />
similarities and differences between<br />
<strong>Australia</strong>’s voluntary adm<strong>in</strong>istration<br />
and the United States’ Chapter 11<br />
regimes, based on the <strong>Australia</strong>n<br />
Government’s, Corporations and Markets<br />
Advisory Committee, Discussion Paper,<br />
‘Rehabilitat<strong>in</strong>g large and complex<br />
enterprises <strong>in</strong> f<strong>in</strong>ancial difficulties’,<br />
September 2003.<br />
21
AUSTRALIA’S VOLUNTARY ADMINISTRATION VS US CHAPTER 11 PROCEDURE<br />
<strong>Australia</strong> – Voluntary adm<strong>in</strong>istration<br />
US – Chapter 11 procedure<br />
Prerequisites Insolvency or likely <strong>in</strong>solvency. Good faith only.<br />
Who can commence<br />
the procedure?<br />
Benefits <strong>in</strong> appo<strong>in</strong>t<strong>in</strong>g<br />
Role of the court<br />
<strong>in</strong> commenc<strong>in</strong>g<br />
the procedure and<br />
approv<strong>in</strong>g the plan<br />
Who controls the<br />
company dur<strong>in</strong>g the<br />
rehabilitation procedure<br />
Committees or creditors<br />
Information to creditors<br />
Moratorium on claims<br />
aga<strong>in</strong>st the company<br />
Ability of contract<br />
counterparties to<br />
enforce ipso facto clauses<br />
Ability of creditors to<br />
exercise set-off rights<br />
Liability for<br />
goods and services<br />
Ability to<br />
disclaim contracts<br />
Avoid<strong>in</strong>g prior transactions<br />
Loan f<strong>in</strong>anc<strong>in</strong>g dur<strong>in</strong>g<br />
rehabilitation procedure<br />
Who devises<br />
rehabilitation plan<br />
Duration of<br />
exclusivity period<br />
Approval of<br />
rehabilitation plan<br />
Majority required to<br />
approve the plan<br />
Rehabilitation plan b<strong>in</strong>d<strong>in</strong>g<br />
secured creditors<br />
Rehabilitation plan<br />
discrim<strong>in</strong>at<strong>in</strong>g between<br />
creditors<br />
The directors, a liquidator or provisional<br />
liquidator or a substantial chargee.<br />
Directors can avoid <strong>in</strong>curr<strong>in</strong>g liability<br />
for <strong>in</strong>solvent trad<strong>in</strong>g.<br />
Recent amendments enhance flexibility<br />
<strong>in</strong> balance sheet restructur<strong>in</strong>g.<br />
No mandatory role <strong>in</strong> either situation, though<br />
the court has various ancillary powers<br />
exercisable on application.<br />
The adm<strong>in</strong>istrator, who must be a<br />
registered liquidator.<br />
Limited functions, namely to consult with<br />
adm<strong>in</strong>istrator <strong>in</strong> relation to the adm<strong>in</strong>istration<br />
and consider reports by the adm<strong>in</strong>istrator.<br />
Report by the adm<strong>in</strong>istrator about the<br />
company’s bus<strong>in</strong>ess, property, affairs<br />
and f<strong>in</strong>ancial circumstances and a<br />
recommendation about what is to be done.<br />
Automatic moratorium, with significant<br />
exceptions for some secured creditors<br />
and property owners.<br />
Yes.<br />
Yes.<br />
Adm<strong>in</strong>istrator personally liable, with a right to<br />
an <strong>in</strong>demnity out of the company’s assets.<br />
Company can generally repudiate<br />
contracts, with counterparty rank<strong>in</strong>g<br />
as unsecured creditor.<br />
Adm<strong>in</strong>istrator cannot avoid<br />
pre-adm<strong>in</strong>istration transactions.<br />
Lender is an ord<strong>in</strong>ary unsecured creditor<br />
of the company, but recent legislative<br />
amendments allow for priority to be<br />
adjusted with secured creditors’ consent.<br />
The adm<strong>in</strong>istrator, although other parties<br />
can put forward proposals.<br />
Approximately 1 month, subject to<br />
the court extend<strong>in</strong>g the period.<br />
One meet<strong>in</strong>g of all creditors.<br />
50% majority by number and by value of all<br />
the creditors who vote.<br />
Yes, if the secured creditors agree or the<br />
court so orders.<br />
The creditors can approve a deed that<br />
discrim<strong>in</strong>ates aga<strong>in</strong>st particular creditors, but<br />
cannot alter employees’ priority rights.<br />
The directors.<br />
To avoid some contracts, avoid some past<br />
transactions and restructure balance sheet.<br />
Procedure <strong>in</strong>itiated by petition to the court.<br />
Cont<strong>in</strong>u<strong>in</strong>g close court <strong>in</strong>volvement <strong>in</strong> the<br />
rehabilitation procedure, <strong>in</strong>clud<strong>in</strong>g f<strong>in</strong>al<br />
approval of plan.<br />
The directors (unless the court orders their<br />
replacement by an <strong>in</strong>dependent trustee).<br />
Major role. Can employ professional advisers at<br />
the company’s expense.<br />
Court-approved disclosure statement.<br />
Automatic moratorium, which applies to all<br />
secured and unsecured creditors.<br />
No.<br />
No.<br />
Company liable as debtor <strong>in</strong> possession, with<br />
debts hav<strong>in</strong>g priority over pre-commencement<br />
unsecured debts.<br />
Company can disclaim executory contracts, with<br />
counterparty rank<strong>in</strong>g as an unsecured creditor.<br />
Company can avoid selected classes<br />
of transactions.<br />
The court can give a lender a priority over all<br />
exist<strong>in</strong>g unsecured creditors and, if necessary,<br />
over exist<strong>in</strong>g secured creditors.<br />
The directors, usually <strong>in</strong> consultation with<br />
professional advisers, dur<strong>in</strong>g the exclusivity<br />
period (see below).<br />
After the exclusivity period, any <strong>in</strong>terested party,<br />
<strong>in</strong>clud<strong>in</strong>g the creditors.<br />
Typically at least 120 days.<br />
Meet<strong>in</strong>gs of each class of creditors.<br />
“Unimpaired” creditors deemed to<br />
have approved plan.<br />
Two-thirds <strong>in</strong> amount, and more than one-half by<br />
number, of creditors who vote, class by class.<br />
A dissent<strong>in</strong>g class can be overridden by the<br />
“cramdown” rules.<br />
Yes, provided:<br />
• if impaired class of secured creditors, at least<br />
one impaired class assents; and<br />
• the plan is fair and equitable.<br />
Under the “absolute priority” rule, senior creditors<br />
are paid before junior creditors. All creditors are<br />
paid before shareholders. One class cannot<br />
receive less than another class with identical<br />
priority without the consent of its members.<br />
22
Receivership<br />
F<strong>in</strong>ancers typically require a debtor<br />
company to provide security, usually a<br />
mortgage debenture, conta<strong>in</strong><strong>in</strong>g a fixed<br />
and float<strong>in</strong>g charge. The debenture usually<br />
allows the f<strong>in</strong>ancier to appo<strong>in</strong>t a receiver<br />
to the debtor upon default under the<br />
<strong>in</strong>strument. A receiver is appo<strong>in</strong>ted to<br />
the company for the purposes of realis<strong>in</strong>g<br />
company assets to discharge the debt<br />
ow<strong>in</strong>g to the secured creditor. Receivers<br />
enjoy sweep<strong>in</strong>g powers under both the<br />
debenture and statute, <strong>in</strong>clud<strong>in</strong>g the power<br />
to take possession of the company’s<br />
assets, realise those assets or carry<br />
on the bus<strong>in</strong>ess of the company.<br />
The terms of the security govern the<br />
appo<strong>in</strong>tment. The secured creditor decides<br />
the identity of the receiver and, <strong>in</strong> do<strong>in</strong>g<br />
so, is under no obligation to consult with<br />
the debtor company. Usually the receiver<br />
is a professional <strong>in</strong>solvency practitioner.<br />
A receiver owes duties pr<strong>in</strong>cipally to the<br />
secured creditor, not to the debtor or its<br />
unsecured creditors. However, a receiver<br />
is subject to statutory duties <strong>in</strong> exercis<strong>in</strong>g<br />
his or her powers, <strong>in</strong>clud<strong>in</strong>g a duty of care<br />
<strong>in</strong> exercis<strong>in</strong>g a power of sale to achieve a<br />
market price. The receiver is also subject<br />
to the supervision of the court and the<br />
corporate regulator, <strong>Australia</strong>n Securities<br />
and Investments Commission (ASIC).<br />
The appo<strong>in</strong>tment of a receiver offers<br />
considerable advantages <strong>in</strong> terms<br />
of immediate control (particularly of<br />
commencement, which may take only<br />
1 to 2 days), cost and flexibility. However,<br />
it does not create a moratorium on<br />
the <strong>in</strong>itiation or commencement of<br />
proceed<strong>in</strong>gs aga<strong>in</strong>st the debtor.<br />
In a very limited number of cases<br />
a court is given the statutory power<br />
to appo<strong>in</strong>t a receiver.<br />
Usually a deed of <strong>in</strong>demnity is provided<br />
by the secured creditor to the receiver.<br />
The timeframe required for a receivership<br />
to be completed depends on the<br />
complexity of the receivership and the<br />
receiver’s ability to recover the secured<br />
creditor’s security. A company can<br />
concurrently be under both adm<strong>in</strong>istration<br />
and receivership. Creditors with a<br />
charge over all or substantially all of<br />
a company’s assets can choose to<br />
appo<strong>in</strong>t a receiver “over the top” of an<br />
adm<strong>in</strong>istrator. The receiver can then deal<br />
with the secured assets unfettered by the<br />
adm<strong>in</strong>istration. Accord<strong>in</strong>gly a prospective<br />
purchaser of assets would usually deal<br />
with the receiver, and not the adm<strong>in</strong>istrator.<br />
Such concurrent appo<strong>in</strong>tments (especially<br />
to large companies) are common.<br />
However, concurrent appo<strong>in</strong>tments<br />
can make balance sheet restructur<strong>in</strong>g<br />
very difficult, given that the focus of<br />
secured creditors is usually the sale<br />
of secured assets.<br />
Liquidation<br />
W<strong>in</strong>d<strong>in</strong>g up may be <strong>in</strong>itiated by court<br />
order (w<strong>in</strong>d<strong>in</strong>g up <strong>in</strong> <strong>in</strong>solvency) usually<br />
upon a creditor’s petition, or by the<br />
creditors (creditors’ voluntary w<strong>in</strong>d<strong>in</strong>g up).<br />
A simple creditors’ voluntary w<strong>in</strong>d<strong>in</strong>g up<br />
takes between 6 to 8 weeks and entails<br />
various notices and meet<strong>in</strong>gs. A complex<br />
w<strong>in</strong>d<strong>in</strong>g up, which may <strong>in</strong>volve recovery<br />
actions be<strong>in</strong>g pursued through the courts,<br />
could take considerably longer.<br />
The liquidator w<strong>in</strong>ds up the company<br />
and applies the assets to satisfy the<br />
liabilities and distributes any surplus to the<br />
shareholders. The directors’ powers cease<br />
upon the appo<strong>in</strong>tment of the liquidator.<br />
There is a stay on proceed<strong>in</strong>gs aga<strong>in</strong>st<br />
the company. Liquidators have extensive<br />
forensic recovery powers, can recover<br />
voidable transactions and br<strong>in</strong>g<br />
claims aga<strong>in</strong>st directors.<br />
Set out on page 24 is a table that<br />
outl<strong>in</strong>es the liquidation priority regime<br />
for secured creditors for both fixed<br />
and float<strong>in</strong>g charge assets.<br />
23
LIQUIDATION PRIORITY REGIME<br />
Realisation of fixed charge assets<br />
(e.g. property, plant, equipment<br />
and goodwill)<br />
Priority waterfall<br />
Costs of realis<strong>in</strong>g fixed charge assets<br />
Secured creditor debts<br />
Employee entitlements<br />
Unsecured creditors<br />
Shareholders<br />
Realisation of float<strong>in</strong>g charge assets<br />
(e.g. stock, work <strong>in</strong> progress and debtors)<br />
Priority waterfall<br />
Costs of realis<strong>in</strong>g float<strong>in</strong>g charge assets<br />
Employee entitlements<br />
Secured creditor debts<br />
Unsecured creditors<br />
Shareholders<br />
Recover<strong>in</strong>g debts from<br />
<strong>in</strong>dividuals: Bankruptcy<br />
and sale under a<br />
mortgage/foreclosure<br />
An issue that frequently arises for portfolio<br />
sales of non-perform<strong>in</strong>g loans concerns<br />
the ability to enforce aga<strong>in</strong>st <strong>in</strong>dividuals’<br />
real property. The relevant timeframes<br />
and operation of personal foreclosure<br />
and bankruptcy laws can be relevant<br />
to considerations.<br />
A lender’s power of sale is heavily<br />
regulated. Generally, a lender can enforce<br />
its power of sale over mortgaged property<br />
1 month after the borrower’s default. The<br />
timeframe and procedures are lengthy and<br />
complex and they vary from State to State.<br />
If a lender fails to recover all of its funds<br />
from the sale of property, the lender<br />
has recourse to the borrower for the<br />
outstand<strong>in</strong>g amount. This is the most<br />
important dist<strong>in</strong>ction between <strong>Australia</strong>n<br />
real property mortgages and those of<br />
the United States.<br />
To realise this amount, the lender can use<br />
the bankruptcy procedure. This can be<br />
quick and effective if the borrower, anxious<br />
to avoid bankruptcy, f<strong>in</strong>ds funds to pay<br />
the outstand<strong>in</strong>g amount with<strong>in</strong> 21 days<br />
(see page 25). However, the process<br />
can take months if the bankruptcy runs<br />
its course, especially if the borrower<br />
contests the bankruptcy notice.<br />
24
Recapitalis<strong>in</strong>g a distressed company<br />
can be achieved either <strong>in</strong>formally or<br />
through a formal <strong>in</strong>solvency procedure.<br />
Bankruptcy<br />
BANKRUPTCY TIMEFRAME<br />
Action<br />
Creditor issues bankruptcy notice,<br />
demand<strong>in</strong>g payment<br />
If person ignores notice a creditor’s<br />
petition for bankruptcy can be made<br />
In all cases there is an application<br />
to court for a creditor’s petition<br />
for bankruptcy<br />
Court determ<strong>in</strong>es application (if<br />
successful, court sequesters bankrupt’s<br />
assets and appo<strong>in</strong>ts a Trustee)<br />
Trustee notifies creditors of<br />
the bankruptcy<br />
Trustee’s report to creditors on likelihood<br />
of receiv<strong>in</strong>g dividends<br />
Trustee may pay dividends, <strong>in</strong>terim<br />
and f<strong>in</strong>al<br />
Timeframe<br />
First step<br />
At least 21 days after the bankruptcy<br />
notice<br />
With<strong>in</strong> 7-14 days of the expiry of<br />
the bankruptcy notice, but not more<br />
than 6 months<br />
With<strong>in</strong> 4 to 8 weeks of application<br />
After 42 days of Trustee’s appo<strong>in</strong>tment<br />
After 3 months of Trustee’s appo<strong>in</strong>tment<br />
Usually after 3 months<br />
of Trustee’s appo<strong>in</strong>tment<br />
How much will it cost to collect?<br />
The costs of collect<strong>in</strong>g the debts can<br />
<strong>in</strong>clude a wide range of costs which will<br />
need to be factored <strong>in</strong> to any valuation<br />
calculation. Investors will typically factor<br />
<strong>in</strong> any of the follow<strong>in</strong>g costs:<br />
• The cost of servic<strong>in</strong>g the portfolio.<br />
This will usually be provided by a third<br />
party servic<strong>in</strong>g company. There are<br />
a number of such organisations <strong>in</strong><br />
<strong>Australia</strong>, primarily set up to service the<br />
consumer debt market, however some<br />
also have corporate capabilities<br />
• Adm<strong>in</strong>istration costs of the purchaser<br />
• Tax costs which will typically need to<br />
take <strong>in</strong>to account corporate profits<br />
tax and withhold<strong>in</strong>g tax on repatriat<strong>in</strong>g<br />
profits if the <strong>in</strong>vestor is offshore.<br />
Corporate profits tax is generally around<br />
30%, whereas <strong>in</strong>terest withhold<strong>in</strong>g tax<br />
<strong>in</strong> <strong>Australia</strong> is generally around 10%<br />
• Other specific costs such as legal<br />
costs, auction costs, commission<br />
costs and stamp duty costs.<br />
25
What is the risk associated with the purchase?<br />
There are many factors that may be taken <strong>in</strong>to<br />
account when determ<strong>in</strong><strong>in</strong>g the discount rate to be<br />
applied to the net present value of the future cash<br />
flow. One approach is to apply a formula and calculate<br />
the weighted average cost of capital. This takes <strong>in</strong>to<br />
account such variables as the risk free rate, country<br />
risk premium, debt to equity ratio, cost of debt<br />
and the effective tax rate.<br />
Any calculation however will need to be compared<br />
to the <strong>in</strong>vestor’s desired <strong>in</strong>ternal rate of return for<br />
distressed <strong>in</strong>vestments, whether they be portfolios<br />
or s<strong>in</strong>gle credits. A common theme that many of<br />
the larger <strong>in</strong>vestors have expressed is that they are<br />
work<strong>in</strong>g <strong>in</strong> a global environment and they are therefore<br />
compet<strong>in</strong>g aga<strong>in</strong>st returns <strong>in</strong> deals <strong>in</strong> Europe and<br />
the US. If they can get similar or better returns on<br />
deals <strong>in</strong> other markets, then it is hard to get these<br />
past credit committees. As such most <strong>in</strong>vestors have<br />
<strong>in</strong>dicated they are work<strong>in</strong>g on <strong>in</strong>ternal rates of returns<br />
<strong>in</strong> excess of 20 – 25%. For more <strong>in</strong>formation on<br />
us<strong>in</strong>g secured convertible notes see page 34.<br />
Sons of Gwalia risk – shareholders as unsecured creditors<br />
The <strong>Australia</strong>n High Court case of Sons of Gwalia v Margaretic (Sons of Gwalia decision) confirmed<br />
that shareholders <strong>in</strong> publicly listed companies may prove as unsecured creditors <strong>in</strong> the adm<strong>in</strong>istration<br />
or liquidation of the company <strong>in</strong> respect of a successfully established claim for mislead<strong>in</strong>g and<br />
deceptive conduct or non-compliance with the cont<strong>in</strong>uous disclosure regime by the company<br />
prior to its <strong>in</strong>solvency. Such claims are generally founded on a company’s failure to disclose<br />
its true f<strong>in</strong>ancial state to the market.<br />
The circumstances <strong>in</strong> which a shareholder will be able to establish a claim are limited, both <strong>in</strong> relation<br />
to the factual and legal circumstances. For example, there will usually be practical difficulties <strong>in</strong><br />
establish<strong>in</strong>g such claims, particularly <strong>in</strong> prov<strong>in</strong>g the elements of reliance on the alleged mislead<strong>in</strong>g<br />
and deceptive conduct and causation (there is no “fraud on the market” <strong>in</strong> <strong>Australia</strong>).<br />
While these shareholder claims may be difficult to establish, the existence of such potential claims must<br />
be considered <strong>in</strong> valu<strong>in</strong>g distressed debt s<strong>in</strong>ce such claims may dilute the value of the unsecured debt.<br />
Follow<strong>in</strong>g the Sons of Gwalia decision the <strong>Australia</strong>n Federal Government commissioned<br />
the Corporations and Markets Advisory Committee (CAMAC) to exam<strong>in</strong>e whether the law<br />
should be changed. CAMAC released its report on 29 January <strong>2009</strong>.<br />
While its members were not <strong>in</strong> complete agreement, CAMAC recommended that legislative reform<br />
was not required to overturn the Sons of Gwalia decision or to postpone, cap or prohibit aggrieved<br />
shareholder claims. CAMAC considered that any move to limit the rights of recourse of aggrieved<br />
shareholders where a company is f<strong>in</strong>ancially distressed could be seen as underm<strong>in</strong><strong>in</strong>g apparent<br />
legislative aims to provide shareholders with direct rights of action <strong>in</strong> respect of corporate misconduct.<br />
The <strong>Australia</strong>n Federal Government is consider<strong>in</strong>g CAMAC’s recommendations. Legislative reform<br />
would be required to reverse or limit the effect of the Sons of Gwalia decision and it is unlikely that the<br />
<strong>Australia</strong>n Federal Government will make any decision on this issue for quite awhile. Until there is any<br />
legislative reform, shareholders will be able to make claims aga<strong>in</strong>st an <strong>in</strong>solvent company based on the<br />
fact that they were misled <strong>in</strong>to buy<strong>in</strong>g shares <strong>in</strong> the company and will be treated as unsecured creditors<br />
<strong>in</strong> respect of those claims.<br />
If <strong>in</strong>vestors acquire secured debt or <strong>in</strong>vest <strong>in</strong> distressed companies us<strong>in</strong>g secured convertible notes,<br />
this risk can be avoided.<br />
26
Perspective<br />
• The first step is assess<strong>in</strong>g the value of the distressed debt.<br />
• Sellers of distressed debt need to be aware of the factors which determ<strong>in</strong>e<br />
the value of the loan portfolio and the buyer’s key considerations. Pric<strong>in</strong>g<br />
depends on various factors <strong>in</strong>clud<strong>in</strong>g the credit approval process, the<br />
quality of the portfolio, the type of sale, the tim<strong>in</strong>g of the sale, and the risks.<br />
• Buyers will consider the type of loans, whether they are corporate or<br />
consumer, how much of the <strong>in</strong>dividual debt can be recovered, whether<br />
the debt is secured or unsecured, how long it will take to collect, how<br />
much this will cost and the risks associated with the debt recovery process.<br />
• Buyers need to be aware of <strong>Australia</strong>n corporate <strong>in</strong>solvency procedures,<br />
the differences between voluntary adm<strong>in</strong>istration, receivership and<br />
liquidation, as well as bankruptcy procedures for <strong>in</strong>dividuals. The key<br />
steps, timeframes, costs of each process, as well as the extent of power<br />
to adm<strong>in</strong>ister and conduct a company’s bus<strong>in</strong>ess are crucial considerations.<br />
• Assess<strong>in</strong>g the risks associated with the purchase is a major consideration.<br />
To determ<strong>in</strong>e the discount rate to be applied to the net present value of<br />
future cash flow, one approach is to calculate the weighted average cost<br />
of capital tak<strong>in</strong>g <strong>in</strong>to account variables such as risk free rate, country risk<br />
premium, debt to equity ratio, cost of debt and the effective tax rate.<br />
• In valu<strong>in</strong>g distressed debt of a company, buyers also need to be aware of<br />
the effect of the <strong>Australia</strong>n High Court case of Sons of Gwalia v Margaretic,<br />
discussed on page 26.<br />
Large foreign <strong>in</strong>vestors have<br />
<strong>in</strong>dicated they are work<strong>in</strong>g<br />
on <strong>in</strong>ternal rates of returns<br />
<strong>in</strong> excess of 20 – 25%.<br />
27
3. Us<strong>in</strong>g secured debt<br />
to control outcomes<br />
and obta<strong>in</strong> ownership<br />
of the assets<br />
A secured creditor who is entitled to enforce a charge over the<br />
whole, or substantially the whole of a company’s property has<br />
wide powers of enforcement especially <strong>in</strong> relation to companies<br />
that may also be <strong>in</strong> adm<strong>in</strong>istration. Such a secured creditor<br />
can elect to appo<strong>in</strong>t a receiver over the secured property<br />
even dur<strong>in</strong>g the first 13 days of an adm<strong>in</strong>istration.<br />
Thus, a secured creditor can opt out<br />
of the voluntary adm<strong>in</strong>istration process<br />
and enforce its security. If the secured<br />
creditor fails to take this step with<strong>in</strong> the<br />
13 days it will be unable to enforce its<br />
security dur<strong>in</strong>g the period of the voluntary<br />
adm<strong>in</strong>istration; however a practice has<br />
developed whereby adm<strong>in</strong>istrators extend<br />
this period <strong>in</strong> order to encourage secured<br />
creditors to support their appo<strong>in</strong>tment.<br />
In the case of a secured creditor whose<br />
entitlement does not extend to the whole<br />
or substantially the whole of the company’s<br />
property, then that secured creditor will<br />
be unable to appo<strong>in</strong>t a receiver without<br />
the adm<strong>in</strong>istrator’s or the court’s consent.<br />
In these circumstances, the secured<br />
creditor becomes subject to the actions<br />
of the voluntary adm<strong>in</strong>istrator dur<strong>in</strong>g the<br />
course of the adm<strong>in</strong>istration. An exception<br />
to this rule arises if the secured creditor<br />
takes steps to enforce its charge before<br />
the appo<strong>in</strong>tment of an adm<strong>in</strong>istrator.<br />
This enforcement power may, however,<br />
be restricted by the court on an<br />
application by the adm<strong>in</strong>istrator.<br />
28
A receiver exercis<strong>in</strong>g a f<strong>in</strong>ancier’s power<br />
of sale over secured property must take<br />
reasonable care to sell the property<br />
at no less than its market value.<br />
Vot<strong>in</strong>g ability<br />
In a receivership, the receiver realises<br />
assets for the benefit of the secured<br />
creditor and there is no process for<br />
unsecured creditors to vote. Therefore<br />
unsecured creditors have limited formal<br />
<strong>in</strong>put <strong>in</strong>to or <strong>in</strong>fluence over a receivership.<br />
In a voluntary adm<strong>in</strong>istration, the future<br />
of the company is decided by a vote of<br />
creditors. Resolutions are passed by a<br />
majority <strong>in</strong> number and value. If there<br />
is a deadlock, the chairman of the<br />
meet<strong>in</strong>g (the adm<strong>in</strong>istrator) has a cast<strong>in</strong>g<br />
vote. The cast<strong>in</strong>g vote may (but will<br />
not always) be exercised <strong>in</strong> accordance<br />
with the vote of the majority of the value<br />
of the creditor pool. Thus, a party that<br />
controls more than 50% of the liabilities<br />
of a company <strong>in</strong> adm<strong>in</strong>istration, both<br />
<strong>in</strong> value and number, may have control<br />
of the outcome of vot<strong>in</strong>g and thereby<br />
control the company’s dest<strong>in</strong>y. Employees<br />
typically form the majority of creditors <strong>in</strong><br />
number and thus are an <strong>in</strong>fluential vot<strong>in</strong>g<br />
block. Secured creditors can vote <strong>in</strong> full<br />
without valu<strong>in</strong>g their security.<br />
Duties affect<strong>in</strong>g the power<br />
of sale – section 420A<br />
A receiver exercis<strong>in</strong>g a f<strong>in</strong>ancier’s power<br />
of sale over secured property must take<br />
reasonable care to sell the property at<br />
no less than its market value, or if no<br />
market value can be ascerta<strong>in</strong>ed, at the<br />
best price available <strong>in</strong> the circumstances.<br />
This duty arises under section 420A of<br />
the Corporations Act 2001 (Cth). A similar<br />
duty arises under common law.<br />
These duties of care aim to ensure that<br />
receivers do not sell assets at a discount<br />
simply to recover secured debt quickly<br />
and cheaply at the expense of both the<br />
secured creditor and other creditors.<br />
Generally, <strong>in</strong> order to fulfil these obligations<br />
a receiver will pursue a structured and<br />
public sales process, <strong>in</strong>clud<strong>in</strong>g:<br />
• advertis<strong>in</strong>g the assets and request<strong>in</strong>g<br />
expressions of <strong>in</strong>terest<br />
• undertak<strong>in</strong>g due diligence<br />
• organis<strong>in</strong>g tender bids<br />
• decid<strong>in</strong>g on preferred bidder<br />
• sell<strong>in</strong>g to preferred bidder.<br />
There is no equivalent to section 420A<br />
for voluntary adm<strong>in</strong>istrators, however,<br />
the adm<strong>in</strong>istrator has a duty to act <strong>in</strong><br />
the best <strong>in</strong>terests of creditors and this<br />
<strong>in</strong>cludes realis<strong>in</strong>g market value for assets<br />
sold. In certa<strong>in</strong> circumstances it may be<br />
necessary to sell a bus<strong>in</strong>ess very quickly<br />
dur<strong>in</strong>g an adm<strong>in</strong>istration to preserve<br />
goodwill and avoid the term<strong>in</strong>ation of<br />
contracts. While an adm<strong>in</strong>istrator <strong>in</strong> sell<strong>in</strong>g<br />
assets does not need formal creditors'<br />
approval, usually creditors' views are<br />
considered before a sale is effected.<br />
29
Pre-pack appo<strong>in</strong>tments<br />
A “pre-pack” appo<strong>in</strong>tment occurs <strong>in</strong><br />
a receivership or an adm<strong>in</strong>istration when<br />
the sale of an <strong>in</strong>solvent company, or its<br />
assets, is negotiated by stakeholders<br />
(<strong>in</strong>clud<strong>in</strong>g creditors, shareholders, key<br />
customers and key trade suppliers)<br />
and agreed before the formal<br />
procedure is commenced.<br />
The key advantage of a pre-pack is to<br />
maximise the chances of a rescue for<br />
the company while it rema<strong>in</strong>s a go<strong>in</strong>g<br />
concern without the loss of goodwill<br />
usually associated with an unplanned<br />
<strong>in</strong>solvency announcement. Pre-packs<br />
are commonly used on companies with<br />
contract or service based bus<strong>in</strong>esses.<br />
The process beg<strong>in</strong>s with negotiat<strong>in</strong>g the<br />
pre-pack arrangement. Once agreement<br />
is reached, an adm<strong>in</strong>istrator (or receiver)<br />
is appo<strong>in</strong>ted, and the pre-orda<strong>in</strong>ed sale<br />
of the company or its assets is executed<br />
expeditiously. Because the pre-pack<br />
sale occurs without the bus<strong>in</strong>ess or<br />
its assets be<strong>in</strong>g offered on the open<br />
market, the sale could be impugned as a<br />
breach of the adm<strong>in</strong>istrator’s or receiver’s<br />
duty of care <strong>in</strong> sell<strong>in</strong>g the company or<br />
assets (discussed above). To avoid this,<br />
adm<strong>in</strong>istrators are required to show<br />
that due enquiries were made regard<strong>in</strong>g<br />
the real value of the asset or bus<strong>in</strong>ess<br />
dur<strong>in</strong>g the pre-pack process before the<br />
adm<strong>in</strong>istration, and that the sale cont<strong>in</strong>ues<br />
to be reasonable and <strong>in</strong> the best <strong>in</strong>terests<br />
of creditors after adm<strong>in</strong>istration beg<strong>in</strong>s.<br />
There have been few pre-pack<br />
adm<strong>in</strong>istrations and receiverships to date<br />
<strong>in</strong> <strong>Australia</strong>. This is due to the difficulties of<br />
manag<strong>in</strong>g stakeholders and the concerns<br />
about the duty of the adm<strong>in</strong>istrator or<br />
receiver <strong>in</strong> the sales processes. Although<br />
this concern is legitimate, the pre-pack<br />
sales exist to maximise the value of the<br />
bus<strong>in</strong>ess and its assets and avoid the<br />
loss of goodwill often associated with<br />
unplanned <strong>in</strong>solvencies.<br />
Control strategies<br />
A party look<strong>in</strong>g to <strong>in</strong>vest <strong>in</strong> a distressed<br />
company or its assets will often seek to<br />
acquire secured debt <strong>in</strong> the company as<br />
a first step to ga<strong>in</strong> control and then drive<br />
through a sale or recapitalisation.<br />
30
Perspective<br />
• An important consideration for buyers when assess<strong>in</strong>g a distressed asset is<br />
to assess how much debt is secured because secured debt can be used to<br />
control outcomes and obta<strong>in</strong> ownership of assets.<br />
• A secured creditor who is entitled to enforce a charge over the whole,<br />
or substantially the whole, of a company’s property has wide powers<br />
of enforcement especially <strong>in</strong> relation to companies which may also be<br />
<strong>in</strong> adm<strong>in</strong>istration.<br />
• A control strategy for buyers is to acquire the secured debt and<br />
drive through the sale or recapitalisation.<br />
• Buyers need to be aware of the duties placed on a receiver by the<br />
Corporations Act 2001 and common law when exercis<strong>in</strong>g a f<strong>in</strong>ancier’s power<br />
of sale over secured property to take reasonable care to sell the property<br />
at no less than its market value, or the best price <strong>in</strong> the circumstances.<br />
• If a buyer’s strategy is to preserve value <strong>in</strong> a distressed company such as a<br />
contract or service based bus<strong>in</strong>ess, one strategy is to enter <strong>in</strong>to a “pre-pack”<br />
arrangement, to maximise the value of the bus<strong>in</strong>ess and its assets and avoid<br />
loss of goodwill, associated with unplanned <strong>in</strong>solvencies.<br />
A party look<strong>in</strong>g to <strong>in</strong>vest <strong>in</strong> a distressed<br />
company or its assets will often seek to<br />
acquire secured debt <strong>in</strong> the company as<br />
a first step to ga<strong>in</strong> control and then drive<br />
through a sale or recapitalisation.<br />
31
4. Recapitalis<strong>in</strong>g distressed<br />
listed/unlisted companies<br />
In some cases, recapitalis<strong>in</strong>g a distressed company can<br />
have significant advantages over an asset sale.<br />
These advantages <strong>in</strong>clude:<br />
• Tax advantages – Asset sales can attract<br />
significant stamp duty (although stamp<br />
duties on bus<strong>in</strong>ess assets other than<br />
land are progressively be<strong>in</strong>g phased<br />
out <strong>in</strong> <strong>Australia</strong>)<br />
• Investors can reta<strong>in</strong> company<br />
specific benefits such as the exist<strong>in</strong>g<br />
<strong>in</strong>frastructure of a company’s operations,<br />
<strong>in</strong>clud<strong>in</strong>g contracts and employees.<br />
Recapitalis<strong>in</strong>g a distressed company can<br />
be achieved either <strong>in</strong>formally or through a<br />
formal <strong>in</strong>solvency procedure. A distressed,<br />
though solvent, company and its<br />
lenders may decide that the company<br />
can return to health despite its current<br />
difficulties with debt.<br />
Privately-held companies can be<br />
recapitalised with relative ease. With<br />
supportive lenders and shareholders,<br />
substantial new equity can be <strong>in</strong>jected<br />
quickly and with m<strong>in</strong>imal publicity.<br />
It may even be possible to recapitalise<br />
a distressed company without the<br />
support of its exist<strong>in</strong>g shareholders.<br />
Publicly listed companies face more<br />
complex challenges, although it is equally<br />
possible to recapitalise a distressed<br />
listed company quickly.<br />
The ASX List<strong>in</strong>g Rules generally limit the<br />
amount of equity that can be placed<br />
to an <strong>in</strong>vestor without shareholder<br />
approval to 15% <strong>in</strong> any 12-month period.<br />
<strong>Australia</strong>n takeover laws prevent an<br />
<strong>in</strong>vestor from subscrib<strong>in</strong>g more than<br />
20% of vot<strong>in</strong>g shares <strong>in</strong> a company<br />
without shareholder approval. A significant<br />
feature of shareholder approvals of this<br />
nature is that an expert’s report as to the<br />
proposal’s fairness and reasonableness<br />
is generally required, add<strong>in</strong>g to the<br />
cost and complexity of the proposal.<br />
Obta<strong>in</strong><strong>in</strong>g shareholder approval (and<br />
an expert’s report if one is required)<br />
can result <strong>in</strong> considerable delay <strong>in</strong> the<br />
distressed company gett<strong>in</strong>g access to new<br />
funds, which it may not be able to afford.<br />
However, there are various exceptions<br />
to the shareholder approval requirement<br />
that can be used to facilitate a<br />
recapitalisation quickly. In particular,<br />
exceptions to both the 15% List<strong>in</strong>g<br />
Rule limit and the 20% takeovers law<br />
restriction are available for pro-rata rights<br />
issues (<strong>in</strong>clud<strong>in</strong>g underwritten rights<br />
issues) to shareholders. In addition,<br />
waivers from the general 15% rule can<br />
be sought from ASX to facilitate rights<br />
issues on an “accelerated” basis, which<br />
comb<strong>in</strong>e advantages to the company<br />
of an accelerated <strong>in</strong>stitutional offer (quick<br />
access to funds) with the advantages<br />
to retail shareholders of a rights issue<br />
(m<strong>in</strong>imis<strong>in</strong>g dilution through participation<br />
<strong>in</strong> the recapitalisation).<br />
32
Recent reforms to the voluntary<br />
adm<strong>in</strong>istration regime certa<strong>in</strong>ly<br />
encourage recapitalisations.<br />
Rais<strong>in</strong>g equity is now much easier.<br />
By way of example, suppose an <strong>in</strong>vestor<br />
wishes to participate <strong>in</strong> a recapitalisation<br />
of a listed company <strong>in</strong> desperate need<br />
of funds. The company could make a<br />
placement to the <strong>in</strong>vestor of up to 15%<br />
of the company’s capital. The company<br />
could then announce an accelerated<br />
rights issue, underwritten by the <strong>in</strong>vestor.<br />
Properly structured, the proposal would<br />
enable the company to access the funds<br />
from the placement and the <strong>in</strong>stitutional<br />
component of the rights issue almost<br />
immediately, and enable the <strong>in</strong>vestor to<br />
acquire a significant stake <strong>in</strong> the company<br />
through the placement and by tak<strong>in</strong>g up<br />
its entitlements and any shortfall under the<br />
rights issue without the tim<strong>in</strong>g constra<strong>in</strong>ts,<br />
cost and uncerta<strong>in</strong>ty associated with<br />
seek<strong>in</strong>g shareholder approval for the<br />
recapitalisation proposal.<br />
In general, the techniques available to<br />
listed companies are also available to<br />
managed <strong>in</strong>vestment schemes, such<br />
as real estate <strong>in</strong>vestment trusts and<br />
<strong>in</strong>frastructure vehicles, although additional<br />
considerations arise due to their unique<br />
structure. In particular, amendments<br />
to the entity’s constitution may be<br />
required to facilitate a recapitalisation.<br />
Listed companies are also subject to<br />
cont<strong>in</strong>uous disclosure obligations under<br />
the Corporations Act and the ASX List<strong>in</strong>g<br />
Rules, which <strong>in</strong> broad terms require them<br />
to immediately disclose <strong>in</strong>formation that<br />
would be expected to have a material<br />
effect on price or value to the market as<br />
soon as the company becomes aware<br />
of that <strong>in</strong>formation.<br />
Any recapitalisation proposal will become<br />
public as soon as it is agreed (or perhaps<br />
even dur<strong>in</strong>g negotiation). This can<br />
<strong>in</strong>crease the likelihood of a compet<strong>in</strong>g<br />
proposal emerg<strong>in</strong>g, thereby plac<strong>in</strong>g the<br />
<strong>in</strong>vestor’s proposal at risk, particularly<br />
where the proposal rema<strong>in</strong>s conditional<br />
on announcement (for example, it is<br />
conditional on shareholder approval).<br />
To manage this risk, <strong>in</strong>vestors should<br />
agree appropriate deal protection<br />
measures such as break fees and<br />
arrangements restrict<strong>in</strong>g the company<br />
from negotiat<strong>in</strong>g compet<strong>in</strong>g offers.<br />
Recent reforms to the voluntary<br />
adm<strong>in</strong>istration regime certa<strong>in</strong>ly encourage<br />
recapitalisations. Rais<strong>in</strong>g equity is now<br />
much easier. Adm<strong>in</strong>istrators have a<br />
specific power to transfer shares with<br />
the court’s or shareholders’ permission,<br />
whereas previously, adm<strong>in</strong>istrators had<br />
no right to do so without shareholder<br />
consent. Additionally, adm<strong>in</strong>istrators can<br />
be exempted from the detailed and costly<br />
disclosure obligations associated with<br />
issu<strong>in</strong>g new equity where this is issued <strong>in</strong><br />
exchange for debt. It is also now possible<br />
to change a company’s name without<br />
shareholders’ consent. This is a significant<br />
advantage where chang<strong>in</strong>g the name<br />
might ease a sale, for example, a potential<br />
buyer might want to apply its own brand<br />
to the company. Similarly, the adm<strong>in</strong>istrator<br />
can now apply to the court for permission<br />
for the company to operate without<br />
sett<strong>in</strong>g out the words “Subject to Deed<br />
of Company Arrangement” with its name <strong>in</strong><br />
advertis<strong>in</strong>g or documents. This benefit can<br />
be significant where those om<strong>in</strong>ous words<br />
might alienate customers or suppliers.<br />
33
Secured convertible notes<br />
Secured convertible notes offer <strong>in</strong>vestors<br />
a way to comb<strong>in</strong>e potential equity upside<br />
and control, while protect<strong>in</strong>g themselves<br />
aga<strong>in</strong>st the risk of hav<strong>in</strong>g to compete<br />
aga<strong>in</strong>st a multitude of unanticipated claims<br />
if the recapitalisation should fail. In light<br />
of the decision <strong>in</strong> Sons of Gwalia, which<br />
allows shareholders who believe they<br />
have been misled <strong>in</strong>to buy<strong>in</strong>g shares <strong>in</strong><br />
a company to make a claim aga<strong>in</strong>st an<br />
<strong>in</strong>solvent company and be treated as an<br />
unsecured creditor, secured convertible<br />
notes have become an <strong>in</strong>creas<strong>in</strong>gly<br />
important <strong>in</strong>strument for <strong>in</strong>vestors<br />
<strong>in</strong> distressed entities. For a detailed<br />
discussion of Sons of Gwalia see page 26.<br />
Liability management<br />
through deeds of<br />
company arrangement/<br />
schemes of arrangement<br />
The voluntary adm<strong>in</strong>istration regime <strong>in</strong><br />
<strong>Australia</strong> provides a way for companies<br />
<strong>in</strong> f<strong>in</strong>ancial distress to be reorganised.<br />
A deed of company arrangement is<br />
a mechanism <strong>in</strong>corporated with<strong>in</strong><br />
the voluntary adm<strong>in</strong>istration regime<br />
and allows a company to enter <strong>in</strong>to<br />
compromise arrangements with its<br />
creditors to avoid go<strong>in</strong>g <strong>in</strong>to liquidation.<br />
The law provides for extensive flexibility<br />
when deal<strong>in</strong>g with a deed of company<br />
arrangement so the deed can be drafted<br />
to meet the particular circumstances<br />
of the company and its creditors. The<br />
pass<strong>in</strong>g of a resolution to implement a<br />
deed b<strong>in</strong>ds all of the company’s unsecured<br />
creditors irrespective of whether or not<br />
they voted <strong>in</strong> favour of the resolution.<br />
Conversely, only those secured creditors,<br />
lessors of property and owners that voted<br />
<strong>in</strong> favour of the resolution of a deed will<br />
be bound by it.<br />
The liabilities management of the<br />
<strong>in</strong>solvent company is enhanced by a<br />
deed of company arrangement because,<br />
depend<strong>in</strong>g upon the terms of the deed,<br />
all or some of the company’s pre-exist<strong>in</strong>g<br />
debts and claims may be ext<strong>in</strong>guished<br />
after the deed obligations are met.<br />
Hav<strong>in</strong>g creditors reduce the size of their<br />
claims enhances a company’s ability to<br />
recommence trad<strong>in</strong>g. Unsecured creditors<br />
agree to a reduced return on the basis that<br />
they will receive a greater return from a<br />
deed of company arrangement than they<br />
would if the company went <strong>in</strong>to liquidation.<br />
Creditors may also contemplate receiv<strong>in</strong>g<br />
<strong>in</strong>creased returns from the future trad<strong>in</strong>g of<br />
the company operat<strong>in</strong>g under a deed.<br />
Deeds of company arrangement<br />
have been traditionally used to<br />
restructure a company’s debt capital,<br />
but are now <strong>in</strong>creas<strong>in</strong>gly be<strong>in</strong>g used<br />
to effect a whole of balance sheet<br />
(<strong>in</strong>clud<strong>in</strong>g equity) restructur<strong>in</strong>g.<br />
A scheme of arrangement is an alternative<br />
way for a company to come to a f<strong>in</strong>ancial<br />
agreement with its members and creditors.<br />
The liability management advantages of<br />
a deed of company arrangement can<br />
also be achieved through schemes of<br />
arrangement. Schemes of arrangement<br />
can be useful to manage class action risk.<br />
34
Perspective<br />
• A buyer needs to consider whether revitalis<strong>in</strong>g a distressed company<br />
may have advantages over a sale of assets. Advantages <strong>in</strong>clude<br />
avoid<strong>in</strong>g stamp duty on asset sales and reta<strong>in</strong><strong>in</strong>g company specific<br />
benefits such as the legal <strong>in</strong>frastructure of the company’s operations,<br />
for example contracts and employees.<br />
• Key considerations for this strategy <strong>in</strong>clude whether the company<br />
is still solvent, and whether it is a private or publicly listed company.<br />
• Revitalis<strong>in</strong>g a listed company can be complex, because of ASX List<strong>in</strong>g<br />
Rules and Corporations Act regulatory requirements. The public<br />
disclosure requirements also mean that any recapitalisation proposal<br />
can become public and deal protection measures need to be put<br />
<strong>in</strong> place to manage the risk of compet<strong>in</strong>g proposals.<br />
• Restructur<strong>in</strong>g a company’s debt capital or to effect a whole of<br />
balance sheet restructur<strong>in</strong>g can also be managed through deeds<br />
of company arrangement or schemes of arrangement.<br />
• The taxation consequences of conduct<strong>in</strong>g a bus<strong>in</strong>ess <strong>in</strong> <strong>Australia</strong><br />
need to be considered.<br />
35
5. Why should an <strong>Australia</strong>n<br />
bank sell debt?<br />
Historically <strong>Australia</strong>n banks have not participated <strong>in</strong> the<br />
debt sales market other than on some large deals such<br />
as the Sons of Gwalia adm<strong>in</strong>istration <strong>in</strong> 2003/04 and sales<br />
of past due credit card debts on a forward flow basis.<br />
The reason given for this general level of <strong>in</strong>activity is simply<br />
that they have not had to. Until recently, the <strong>Australia</strong>n<br />
economy had been on an unbroken growth trajectory<br />
s<strong>in</strong>ce the early 1990s. Levels of defaults and hence nonperform<strong>in</strong>g<br />
loans on banks’ balance sheets have been<br />
low, as highlighted <strong>in</strong> the chart, Bad Debt Expenses.<br />
However all this may soon change.<br />
As highlighted <strong>in</strong> the chart, Bad Debt Expenses, the<br />
level of bad debt expenses for the 4 Big Banks began<br />
to rise significantly <strong>in</strong> 2008 and are forecast to <strong>in</strong>crease<br />
further <strong>in</strong> <strong>2009</strong> and 2010. Significantly, <strong>in</strong> dollar terms<br />
bad debt expenses have <strong>in</strong>creased from A$2.2 billion<br />
<strong>in</strong> 1997 to A$6.3 billion <strong>in</strong> 2008 and forecast to <strong>in</strong>crease<br />
to A$14.3 billion <strong>in</strong> 2010.<br />
Why is this period of <strong>in</strong>creased impairments likely to<br />
differ from the early 1990s <strong>in</strong> terms of <strong>Australia</strong>n banks’<br />
attitudes to debt sales? There are several reasons:<br />
• Increased number of buyers<br />
The distressed debt market has expanded significantly<br />
<strong>in</strong> Asia s<strong>in</strong>ce the Asian bank<strong>in</strong>g crisis <strong>in</strong> the late 1990s.<br />
The number of funds and amount of capital dedicated<br />
to this sector has <strong>in</strong>creased considerably, with the 2007<br />
year on track to be a record for rais<strong>in</strong>gs as highlighted<br />
by the graph on the right.<br />
• Management time and focus on workout<br />
Workouts are time consum<strong>in</strong>g, generally complex and can<br />
be costly. As one <strong>Australia</strong>n banker <strong>in</strong>dicated, lend<strong>in</strong>g to<br />
distressed entities is “credit <strong>in</strong>tensive”. In times when there<br />
are so many workout opportunities for banks, the ability to<br />
manage them with limited or scarce resources becomes<br />
an issue. This scarcity of resources is exacerbated by the<br />
strong economic growth over the last 15 years, which<br />
means that sourc<strong>in</strong>g enough skilled staff with good<br />
workout experience has become problematic.<br />
Bad debt expenses<br />
(average across anz, cba, nab and wbc)<br />
BDE % of Assets<br />
2.0%<br />
1.5%<br />
1.0%<br />
0.5%<br />
0.0%<br />
Bad Debt Expenses<br />
(Average across ANZ, CBA, NAB and WBC)<br />
1989<br />
1990<br />
1991<br />
1992<br />
1993<br />
1994<br />
1995<br />
1996<br />
1997<br />
1998<br />
1999<br />
2000<br />
2001<br />
2002<br />
2003<br />
2004<br />
2005<br />
2006<br />
2007<br />
2008<br />
<strong>2009</strong><br />
2010<br />
Source: Company reports and ABN AMRO<br />
distress debt and special<br />
situations fundrais<strong>in</strong>g<br />
2000-2007<br />
30<br />
25<br />
20<br />
15<br />
10<br />
5<br />
0<br />
<strong>Distressed</strong> Debt and Special Situations Fundrais<strong>in</strong>g 2000 - 2007<br />
2000 2001 2002 2003 2004 2005 2006 AUG YTD<br />
2007<br />
No. of Funds<br />
Aggregated Commitments (US$B)<br />
Source: Preq<strong>in</strong> – Special Research Report: <strong>Distressed</strong> Debt and Special Situations Aug 07<br />
36
This is the first year <strong>in</strong> which the full<br />
implications of Basel II will be felt<br />
and there is a real concern that banks<br />
and regulators have not appreciated<br />
the full impact of Basel II as levels<br />
of NPLs <strong>in</strong>crease significantly.<br />
• Basel II implications of carry<strong>in</strong>g NPLs<br />
The major change from the early 1990s<br />
has been the <strong>in</strong>troduction of Basel II.<br />
This is the first year <strong>in</strong> which the full<br />
implications of Basel II will be felt and<br />
there is a real concern that banks<br />
and regulators have not appreciated<br />
the full impact of Basel II as levels of<br />
NPLs <strong>in</strong>crease significantly. In essence,<br />
banks now have to set aside Tier 1<br />
capital to cover the possibility of losses<br />
aga<strong>in</strong>st loans. In the case of NPLs the<br />
percentage of Tier 1 capital required<br />
can be 20% to 25% of the gross loan<br />
value. Therefore if a bank <strong>in</strong> <strong>Australia</strong><br />
has a A$100 million loan to a customer<br />
who has defaulted on repayments, then<br />
where the bank has made a provision<br />
of 45% aga<strong>in</strong>st the loan, it may be<br />
required to set aside up to A$23 million<br />
<strong>in</strong> Tier 1 capital (essentially cash or other<br />
similarly liquid securities). The levels of<br />
specific or general provisions held aga<strong>in</strong>st<br />
loans are not taken <strong>in</strong>to account when<br />
determ<strong>in</strong><strong>in</strong>g the required level of capital<br />
under the Advanced Basel II rules. So <strong>in</strong><br />
the above example the sale of the loan<br />
would free up A$23 million <strong>in</strong> cash to be<br />
otherwise applied to generat<strong>in</strong>g <strong>in</strong>come<br />
for the bank.<br />
From an opportunity cost perspective,<br />
A$23 million <strong>in</strong> Tier 1 capital could<br />
support A$460 million of perform<strong>in</strong>g<br />
corporate loans. This would equate to<br />
approximately A$37 million of <strong>in</strong>terest<br />
per annum at an 8% <strong>in</strong>terest rate.<br />
• Liquidity constra<strong>in</strong>ts brought<br />
on by the global f<strong>in</strong>ancial crisis<br />
Access to liquidity has become a very<br />
real concern for all bus<strong>in</strong>esses <strong>in</strong>clud<strong>in</strong>g<br />
banks. The issue of liquidity for banks<br />
is twofold, firstly to have funds available<br />
to lend <strong>in</strong> to the <strong>Australia</strong>n economy.<br />
Secondly, <strong>in</strong> l<strong>in</strong>e with the po<strong>in</strong>t above,<br />
banks are required to ma<strong>in</strong>ta<strong>in</strong> m<strong>in</strong>imum<br />
capital adequacy ratios. While <strong>Australia</strong>n<br />
banks are not likely to fall below the<br />
m<strong>in</strong>imum levels set by the <strong>Australia</strong>n<br />
regulators, the banks’ cost of fund<strong>in</strong>g<br />
could well <strong>in</strong>crease if their capital ratios<br />
fall below acceptable thresholds.<br />
As a result many <strong>Australia</strong>n banks have<br />
recently raised capital to improve their<br />
Tier 1 capital adequacy ratio. At some<br />
po<strong>in</strong>t however, a tipp<strong>in</strong>g po<strong>in</strong>t will be<br />
reached when it is no longer efficient from<br />
a shareholder return perspective to raise<br />
further capital. At this po<strong>in</strong>t therefore<br />
the bank will need to weigh up if debt<br />
sales represent a more efficient way to<br />
manage the level of Tier 1 capital required.<br />
There is a number of other considerations<br />
that may need to be taken <strong>in</strong> to account by<br />
a bank when consider<strong>in</strong>g sell<strong>in</strong>g its NPLs.<br />
These may <strong>in</strong>clude:<br />
• Realis<strong>in</strong>g a tax benefit from writ<strong>in</strong>g<br />
off a NPL<br />
Under <strong>Australia</strong>n tax law <strong>Australia</strong>n banks<br />
cannot realise a benefit from a NPL<br />
until it is fully written off or the bank has<br />
recovered the net loan proceeds and<br />
crystallised the loss. Therefore, when<br />
banks take general or specific provisions<br />
aga<strong>in</strong>st loans their account<strong>in</strong>g profit is<br />
reduced, however they cont<strong>in</strong>ue to pay<br />
tax on the profit before these provisions.<br />
It is only when the loss is crystallised that<br />
the banks get the tax benefit.<br />
• Opportunity cost of redeploy<strong>in</strong>g<br />
capital tied up <strong>in</strong> a NPL<br />
For the period of a workout or recovery<br />
the bank has the net loan proceeds<br />
effectively tied up and not earn<strong>in</strong>g any<br />
revenue. If the debt were to be sold<br />
the funds could then be on lent to<br />
other borrowers that are generat<strong>in</strong>g<br />
the bank’s required rate of return.<br />
37
• Manag<strong>in</strong>g the bank’s reputation<br />
or brand <strong>in</strong> the market<br />
One of the key assets of each<br />
<strong>Australia</strong>n bank is its brand.<br />
Brand recognition and awareness are<br />
generally very high. Therefore anyth<strong>in</strong>g<br />
that may potentially damage the brand<br />
should be avoided. Brand damage is<br />
likely to come from two ma<strong>in</strong> sources,<br />
with the first centred on the bank’s<br />
f<strong>in</strong>ancial health. Grow<strong>in</strong>g levels of<br />
provisions or NPLs may contribute<br />
to a general level of unease as to a<br />
The graph below is an example of the<br />
above description from an economic<br />
po<strong>in</strong>t of view. In summary if a bank has<br />
a A$100 million loan impaired by 45%<br />
then from an economic po<strong>in</strong>t of view<br />
if the loan can be sold for anyth<strong>in</strong>g greater<br />
than A$32 million, the bank comes out<br />
ahead. However the example does not<br />
take <strong>in</strong> account <strong>in</strong>direct costs such as<br />
management costs, reputation costs or<br />
the opportunity costs associated with<br />
the <strong>in</strong>terest earned from apply<strong>in</strong>g the<br />
Tier 1 capital to perform<strong>in</strong>g loans.<br />
bank’s overall f<strong>in</strong>ancial security. The The example below assumes an<br />
second source is from association 8% <strong>in</strong>terest rate on perform<strong>in</strong>g loans,<br />
with loan foreclosure. There have been 11% cost of capital, a 3 year recovery/<br />
a number of high profile adm<strong>in</strong>istrations workout period of the loan and an<br />
where the banks have had their<br />
annual tax rate of 30%.<br />
names l<strong>in</strong>ked to company closures.<br />
WHAT IS THE ECONOMIC COST OF CARRYING A NPL?<br />
Ecomomic Cost of Carry<strong>in</strong>g a NPL<br />
120<br />
100<br />
$m<br />
80<br />
-45.0<br />
-11.3<br />
60<br />
100<br />
-2.8 -8.5<br />
40<br />
55<br />
20<br />
0<br />
32<br />
Loan value<br />
Specific Provision (F<strong>in</strong>ancial<br />
report<strong>in</strong>g provision)<br />
Net Loan Value (if debt is<br />
sold immediately)<br />
Cost of deferr<strong>in</strong>g<br />
the recovery<br />
Cost of deferr<strong>in</strong>g<br />
the tax benefit<br />
Cost of Capital (<strong>in</strong>terest cost<br />
on capital reqd)<br />
Net Loan Value<br />
(if debt sale is deferred)<br />
Source: PricewaterhouseCoopers<br />
38
Perspective<br />
The ma<strong>in</strong> reasons for <strong>Australia</strong>n banks to consider sell<strong>in</strong>g debt are:<br />
• Increased number of buyers<br />
• Increased costs and complexity of manag<strong>in</strong>g workouts <strong>in</strong>-house<br />
• Basel II implications of carry<strong>in</strong>g NPLs – sett<strong>in</strong>g aside Tier 1 capital<br />
to cover the possibility of losses aga<strong>in</strong>st loans<br />
• Improv<strong>in</strong>g liquidity position<br />
• Realis<strong>in</strong>g a tax benefit from writ<strong>in</strong>g off a NPL<br />
• Redeploy<strong>in</strong>g capital tied up <strong>in</strong> a NPL<br />
• Manag<strong>in</strong>g the bank’s reputation or brand <strong>in</strong> the market<br />
• Manag<strong>in</strong>g market perception.<br />
In dollar terms bad debt expenses have<br />
<strong>in</strong>creased from $2.2 billion <strong>in</strong> 1997 to<br />
$6.3 billion <strong>in</strong> 2008 and are forecast<br />
to <strong>in</strong>crease to $14.3 billion <strong>in</strong> 2010.<br />
39
6. How does a<br />
non‐perform<strong>in</strong>g loan<br />
portfolio sale work?<br />
For the sale of a portfolio of NPLs to be viable,<br />
f<strong>in</strong>ancial <strong>in</strong>stitutions will need to exam<strong>in</strong>e their objectives,<br />
understand the nature of the product they are sell<strong>in</strong>g,<br />
and become familiar with the way the market operates.<br />
Determ<strong>in</strong><strong>in</strong>g what to sell, the method of<br />
sale, the <strong>in</strong>formation about the portfolio<br />
and how to present it are all key aspects<br />
that need to be considered to ensure that<br />
the seller maximises return. Establish<strong>in</strong>g<br />
the key driver for the sale at the beg<strong>in</strong>n<strong>in</strong>g<br />
of the process is a crucial step.<br />
F<strong>in</strong>ancial <strong>in</strong>stitutions pr<strong>in</strong>cipally have two<br />
options for deal<strong>in</strong>g with NPLs – <strong>in</strong>ternal<br />
or external workout, as illustrated below.<br />
Options for deal<strong>in</strong>g with NPLs<br />
Internal workout<br />
External workout<br />
Loans rema<strong>in</strong> on<br />
the balance sheet<br />
Workout by <strong>in</strong>-house<br />
collection department<br />
Outsourc<strong>in</strong>g of the<br />
servic<strong>in</strong>g/workout<br />
Loans leave the<br />
balance sheet<br />
Sale; and cont<strong>in</strong>ued<br />
servic<strong>in</strong>g of the<br />
commitment on<br />
the basis of a<br />
service agreement<br />
Sale; and takeover<br />
of servic<strong>in</strong>g/workout<br />
by an external<br />
service provider<br />
The outsourc<strong>in</strong>g of NPLs to an external<br />
servicer still <strong>in</strong>volves the cont<strong>in</strong>ued<br />
<strong>in</strong>volvement of the bank <strong>in</strong> monitor<strong>in</strong>g<br />
and oversee<strong>in</strong>g portfolio management,<br />
which <strong>in</strong> turn diverts time and focus<br />
from more profitable bank<strong>in</strong>g activities.<br />
An outright sale removes NPLs from<br />
the bank’s balance sheet, favourably<br />
impact<strong>in</strong>g the bank’s overall NPL levels<br />
and capital adequacy, and may allow the<br />
bank to redeploy staff resources to less<br />
time consum<strong>in</strong>g, higher return customers<br />
<strong>in</strong> the early stages of del<strong>in</strong>quency.<br />
Aside from the above general benefits,<br />
banks that <strong>in</strong>tend to conduct a NPL sale<br />
will often have an overrid<strong>in</strong>g objective<br />
for the sale (such as tim<strong>in</strong>g or profit<br />
generation) and this will determ<strong>in</strong>e<br />
the size and composition of the NPL<br />
portfolio to be taken to market and<br />
the sale process.<br />
40
Determ<strong>in</strong><strong>in</strong>g what to sell, the method of<br />
sale, the <strong>in</strong>formation about the portfolio<br />
and how to present it are all key aspects<br />
that need to be considered to ensure<br />
that the seller maximises return.<br />
Benefits of distressed asset sales relative to bank objectives<br />
Bank objectives Asset class Reason<br />
• Improved liquidity position of the<br />
<strong>in</strong>stitution, free<strong>in</strong>g up funds for<br />
new lend<strong>in</strong>g and <strong>in</strong>vestment<br />
• Better capital & debt market<br />
perception, thus reduc<strong>in</strong>g fund<strong>in</strong>g<br />
costs and rais<strong>in</strong>g share price<br />
• Improved rat<strong>in</strong>gs (S&P, Moody’s),<br />
aga<strong>in</strong> reduc<strong>in</strong>g fund<strong>in</strong>g costs and<br />
rais<strong>in</strong>g share price<br />
• Improved capital adequacy position<br />
– particularly <strong>in</strong> light of Basel II<br />
requirements for weight<strong>in</strong>g on NPLs<br />
• Immediate and future positive impact<br />
on profit and loss via possible<br />
provision write backs, utilisation of tax<br />
assets, accelerated recoveries and<br />
sav<strong>in</strong>gs on human resources costs<br />
• Overcome an <strong>in</strong>ability to manage<br />
problem loans <strong>in</strong>-house effectively<br />
• Free<strong>in</strong>g up management time and<br />
focus resources on more profitable<br />
activities/collections<br />
• Release/redeploy staff resources,<br />
thus improv<strong>in</strong>g cost to <strong>in</strong>come ratios<br />
Secured corporate<br />
Secured consumer<br />
Real estate<br />
owned assets<br />
Unsecured corporate<br />
Unsecured retail<br />
Del<strong>in</strong>quent<br />
receivables portfolios<br />
(telco and utility<br />
debts, store cards,<br />
etc.)<br />
• Sale of secured loans is likely to<br />
generate higher values.<br />
• Reduc<strong>in</strong>g the balance sheet doubtful<br />
debt provision and improv<strong>in</strong>g<br />
capital adequacy ratios is generally<br />
viewed favourably by capital and<br />
debt markets and rat<strong>in</strong>g agencies.<br />
However this may need to be traded<br />
off aga<strong>in</strong>st the potential profit and loss<br />
(P&L) impact caused by the differ<strong>in</strong>g<br />
valuation methodologies used by<br />
sellers and buyers.<br />
• Basel II requires Tier 1 capital<br />
requirements to be based on the<br />
gross value of loans rather than the<br />
net value hence sell<strong>in</strong>g higher gross<br />
value NPLs will have a greater impact<br />
on capital adequacy calculations.<br />
• Generally limited or no underly<strong>in</strong>g<br />
collateral and therefore larger<br />
provisions can be raised aga<strong>in</strong>st<br />
these debts mak<strong>in</strong>g it easier to<br />
result <strong>in</strong> a profit on sale.<br />
• Substantial number of customers/<br />
loans with relatively low average<br />
balances outstand<strong>in</strong>g. Requires<br />
a similar amount of contact<br />
and monitor<strong>in</strong>g as a secured<br />
debt but generally has a lower<br />
yield. A reasonable size portfolio<br />
(approximately A$300 million)<br />
could remove up to 60,000 loans<br />
41
Determ<strong>in</strong>ation of the sale structure<br />
The determ<strong>in</strong>ation of the sale structure is also fundamental to the sale process and often<br />
<strong>in</strong>volves consideration of the follow<strong>in</strong>g three strategies:<br />
1. Private placement<br />
• deal structur<strong>in</strong>g<br />
• speed of sale<br />
• <strong>in</strong>formation supplied specifically<br />
tailored to <strong>in</strong>vestor<br />
• confidentiality easier to ma<strong>in</strong>ta<strong>in</strong><br />
• no competition; price reduced<br />
• may not reach highest<br />
potential bidders<br />
• limited widen<strong>in</strong>g of general<br />
<strong>in</strong>vestor base<br />
• less certa<strong>in</strong>ty for <strong>in</strong>vestors<br />
2. Auction (limited or open public)<br />
• reasonably quick process<br />
• price maximised<br />
• wide base of professional<br />
<strong>in</strong>vestors reached<br />
• one-off process<br />
• <strong>in</strong>formation needs are wide<br />
but rema<strong>in</strong> controllable<br />
• will not reach all potential <strong>in</strong>vestors<br />
• process requires more management<br />
3. Securitisation<br />
• reaches widest potential <strong>in</strong>vestor base<br />
• maximum profile<br />
• debtor relationship reta<strong>in</strong>ed<br />
• issues can be “topped up”<br />
with later portfolios<br />
• requires rat<strong>in</strong>g; extensive<br />
<strong>in</strong>formation requirements<br />
• ongo<strong>in</strong>g management required<br />
• higher <strong>in</strong>itial costs<br />
• subject to current market uncerta<strong>in</strong>ty<br />
42
SALE PROCESS<br />
Notwithstand<strong>in</strong>g the sale type, the sale process often <strong>in</strong>volves the follow<strong>in</strong>g four work phases, with each phase<br />
be<strong>in</strong>g <strong>in</strong>terconnected:<br />
Project<br />
Plann<strong>in</strong>g<br />
Phase 1<br />
Portfolio<br />
Identification<br />
& Valuation<br />
Phase 2<br />
Strategy<br />
Development<br />
Phase 3<br />
Sale<br />
Preparation<br />
Phase 4<br />
Execution<br />
Confirm your overall<br />
goals and objectives<br />
Portfolio identification<br />
and classification<br />
Develop overall<br />
sale strategy<br />
Development of bid<br />
documents and SPA<br />
Investor and<br />
sale management<br />
F<strong>in</strong>alise<br />
work program<br />
Due diligence<br />
review and validation<br />
Establish due<br />
diligence and data<br />
room procedures<br />
Negotiation<br />
support<br />
Valuation<br />
Market<strong>in</strong>g of the<br />
sale transaction<br />
Clos<strong>in</strong>g<br />
Project Management<br />
The three sale processes on page 42<br />
should not be considered mutually<br />
exclusive. One strategy may apply to<br />
the whole portfolio or to different pools<br />
or each of the three strategies could be<br />
applied to different asset pools depend<strong>in</strong>g<br />
on an assessment of how value will<br />
be maximised and the seller’s exact<br />
priorities. For example, if maximis<strong>in</strong>g<br />
the net proceeds is paramount, then<br />
an auction or securitisation process<br />
would be preferable. If speed of sale or<br />
confidentiality of <strong>in</strong>formation is paramount,<br />
then a private placement is likely to provide<br />
the quickest exit route.<br />
Given the recent <strong>in</strong>crease <strong>in</strong> the supply<br />
of NPLs <strong>in</strong> the global market created<br />
by the recent global f<strong>in</strong>ancial crisis,<br />
coupled with competition for <strong>in</strong>vestor<br />
resources, the NPL market appears to<br />
have moved from what was considered<br />
a “seller’s” market pre 2007 to a more<br />
“buyer” centric market. This may impact<br />
the sale structures go<strong>in</strong>g forward as<br />
generally buyers will show a preference<br />
for bilateral deals.<br />
<strong>Distressed</strong> asset loan portfolios have<br />
become an established asset class<br />
for many <strong>in</strong>ternational distressed debt<br />
<strong>in</strong>vestors. The major distressed debt<br />
<strong>in</strong>vestors have developed unique skills<br />
and expertise <strong>in</strong> buy<strong>in</strong>g and work<strong>in</strong>g<br />
out NPL portfolios throughout the<br />
US, Asia and Europe and can often<br />
negotiate deals with borrowers that<br />
are unfeasible for the orig<strong>in</strong>ator due to<br />
political or market perception reasons.<br />
Unlike banks, unlock<strong>in</strong>g value <strong>in</strong> NPLs is<br />
the core bus<strong>in</strong>ess of a distressed debt<br />
<strong>in</strong>vestor and they use proven collection<br />
methodologies <strong>in</strong> order to achieve this.<br />
For this reason such <strong>in</strong>vestors are will<strong>in</strong>g<br />
to pay competitive prices to ga<strong>in</strong> access<br />
to such assets/markets.<br />
To diversify their exposures, distressed<br />
debt <strong>in</strong>vestors are beg<strong>in</strong>n<strong>in</strong>g to look<br />
outside the traditional and established NPL<br />
markets. However, these <strong>in</strong>vestors have<br />
come to expect sale processes and legal<br />
documents to be reasonably consistent<br />
from country to country. Comb<strong>in</strong>e this<br />
expectation with the fact that one of<br />
the key determ<strong>in</strong>ants of value for an<br />
<strong>in</strong>vestor is the speed with which they<br />
can start “work<strong>in</strong>g” the portfolio and it is<br />
clear that the <strong>in</strong>formation prepared and<br />
presented to <strong>in</strong>vestors as part of the due<br />
diligence process is critical to the success<br />
of any sale.<br />
Investors have very specific <strong>in</strong>formation<br />
requirements when bidd<strong>in</strong>g for distressed<br />
assets and some of this <strong>in</strong>formation can<br />
take time to collect. Contact<strong>in</strong>g <strong>in</strong>vestors<br />
and commenc<strong>in</strong>g a sale process without<br />
the required <strong>in</strong>formation will most probably<br />
result <strong>in</strong> a long drawn out sale process,<br />
which <strong>in</strong> turn will both <strong>in</strong>crease the cost<br />
of participat<strong>in</strong>g <strong>in</strong> the sale and decrease<br />
the overall value of the portfolio.<br />
43
To maximise value for <strong>in</strong>vestors and, ultimately through<br />
higher prices provide more value for the bank, it is<br />
considered market best practice to consider the<br />
follow<strong>in</strong>g (<strong>in</strong> conjunction with appo<strong>in</strong>t<strong>in</strong>g a qualified<br />
sell-side advisor):<br />
• Consistent sales process – Investors are look<strong>in</strong>g<br />
for a professional sales process and confidence that<br />
the seller will proceed with the transaction clos<strong>in</strong>g<br />
at a realistic market-based price.<br />
• Quality and timely <strong>in</strong>formation – Investors<br />
require quality <strong>in</strong>formation to m<strong>in</strong>imise additional<br />
risk discount<strong>in</strong>g and maximise value. Key<br />
<strong>in</strong>formation <strong>in</strong>cludes historical data, virtual data<br />
rooms, representative sample <strong>in</strong>formation of<br />
scanned documentation, updated real estate<br />
appraisals for collateralised assets, past<br />
collection policies, repayment plans, recent<br />
borrower correspondence, f<strong>in</strong>ancial <strong>in</strong>formation<br />
on large corporate borrowers, and standardised<br />
market‐based legal sale documentation.<br />
• Simple sale process – From an <strong>in</strong>vestor’s<br />
perspective the less complex the sale process the<br />
better. A process with too many bid stages or that is<br />
unstructured can be time consum<strong>in</strong>g and confus<strong>in</strong>g<br />
for <strong>in</strong>vestors. It can also make it difficult for the seller<br />
to compare bids at the end of the process.<br />
• Reliable and realistic sale timetable – A timetable<br />
that is adhered to by the bank and <strong>in</strong>vestors<br />
limits the resource commitment from the bank<br />
and the <strong>in</strong>vestor.<br />
A key area of concern for sellers of debt revolves<br />
around the confidentiality of the borrower’s<br />
<strong>in</strong>formation. The ability of a lender to trade a<br />
borrower’s debt <strong>in</strong> circumstances where they<br />
have confidential <strong>in</strong>formation may be restricted<br />
by obligations of confidence and <strong>in</strong>sider trad<strong>in</strong>g<br />
laws. It may also be impacted if the lender has<br />
a representative on a creditors’ committee.<br />
Lenders will typically be provided with access to<br />
f<strong>in</strong>ancial and other sensitive <strong>in</strong>formation about a<br />
borrower which is subject to express or implied<br />
obligations to keep the <strong>in</strong>formation confidential or<br />
to use it only for certa<strong>in</strong> specific purposes (such as<br />
monitor<strong>in</strong>g performance of the company). The lender<br />
may breach its duty of confidentiality to the borrower<br />
if it discloses <strong>in</strong>formation to a prospective buyer<br />
of the debt without the borrower’s consent.<br />
Confidential <strong>in</strong>formation received from a borrower or<br />
<strong>in</strong>formation about the status of the debt (e.g. potential<br />
default or a proposed restructure of the terms) may<br />
be price sensitive and therefore “<strong>in</strong>side <strong>in</strong>formation”<br />
for the purpose of the <strong>in</strong>sider trad<strong>in</strong>g laws. If the debt<br />
is a f<strong>in</strong>ancial product to which the <strong>in</strong>sider trad<strong>in</strong>g laws<br />
apply (e.g. notes, bonds or debentures issued by the<br />
borrower) possession of <strong>in</strong>side <strong>in</strong>formation prevents<br />
the lender from deal<strong>in</strong>g <strong>in</strong> the debt until the <strong>in</strong>side<br />
<strong>in</strong>formation becomes generally available or ceases<br />
to be price sensitive.<br />
Some strategies to limit the risk of liability <strong>in</strong>clude<br />
the use of “Ch<strong>in</strong>ese walls” to manage receipt of<br />
confidential <strong>in</strong>formation and to ensure the lender’s<br />
flexibility <strong>in</strong> trad<strong>in</strong>g the debt, and only trad<strong>in</strong>g under<br />
<strong>in</strong>formation symmetry between counterparties, such<br />
as between other creditor committee members or<br />
other <strong>in</strong>vestors with the same degree of knowledge.<br />
Lenders can also <strong>in</strong>clude specific provisions <strong>in</strong><br />
their lend<strong>in</strong>g documentation to facilitate distressed<br />
debt trades. This may extend to a requirement<br />
that the borrower confirms the accuracy and<br />
currency of f<strong>in</strong>ancial <strong>in</strong>formation if the lender<br />
<strong>in</strong>tends a debt transfer.<br />
In addition, publicly listed borrowers are subject to<br />
cont<strong>in</strong>uous disclosure obligations, which <strong>in</strong> broad<br />
terms require them to immediately disclose <strong>in</strong>formation<br />
that would be expected to have a material effect<br />
on price or value to ASX as soon as the company<br />
becomes aware of that <strong>in</strong>formation.<br />
In its Companies Update 02/08 issued last year,<br />
ASX made it clear that listed entities that have<br />
<strong>in</strong> place (or have put <strong>in</strong> place or altered) material<br />
f<strong>in</strong>anc<strong>in</strong>g arrangements which conta<strong>in</strong> covenants<br />
that may be triggered on certa<strong>in</strong> events occurr<strong>in</strong>g,<br />
may need to disclose details of the arrangements<br />
at the time the covenants are (or are likely to<br />
be) activated. Disclosure may need to <strong>in</strong>clude<br />
details of the covenants <strong>in</strong> question, as well as<br />
other <strong>in</strong>formation such as any impact that the<br />
trigger<strong>in</strong>g of the covenant may have on the entity’s<br />
relationship with its bankers, its f<strong>in</strong>ancial position<br />
and its f<strong>in</strong>ancial performance (to the extent that<br />
<strong>in</strong>formation is material). In practice, market disclosure<br />
of this nature may overcome the lender’s <strong>in</strong>ability<br />
to deal with the debt by reason of confidentiality<br />
constra<strong>in</strong>ts or possess<strong>in</strong>g “<strong>in</strong>side <strong>in</strong>formation”.<br />
44
Perspective<br />
• As a seller, a bank or f<strong>in</strong>ancial <strong>in</strong>stitution needs to make sure the sale<br />
of a portfolio of NPLs is viable, by exam<strong>in</strong><strong>in</strong>g their bus<strong>in</strong>ess objectives,<br />
understand<strong>in</strong>g the nature of the product, and becom<strong>in</strong>g familiar<br />
with buyers’ needs and the way the market operates.<br />
• Sellers need to determ<strong>in</strong>e their sale strategies, <strong>in</strong>clud<strong>in</strong>g whether<br />
to sell by private placement, auction (limited or open to the public)<br />
or by securitisation, depend<strong>in</strong>g on their objectives.<br />
• To ensure successful sales banks need to be aware that the buyers<br />
are sophisticated and have expectations of consistent sale processes<br />
and legal documentation, quality and timely <strong>in</strong>formation, and a reliable<br />
and realistic sale timetable.<br />
• A seller also needs to be careful not to breach its duty of confidentiality<br />
to the borrower and put strategies <strong>in</strong> place to limit the risk of liability<br />
for the purpose of <strong>in</strong>sider trad<strong>in</strong>g laws.<br />
Given the recent <strong>in</strong>crease <strong>in</strong> the supply<br />
of NPLs <strong>in</strong> the global market, the NPL<br />
market appears to have moved from<br />
a “sellers” market pre 2007 to a more<br />
“buyer” centric market.<br />
45
7. Structur<strong>in</strong>g options for<br />
sellers of debt/assets<br />
In the current economic climate the biggest obstacle<br />
to gett<strong>in</strong>g a deal closed is the difference between the<br />
bid price and the ask<strong>in</strong>g price for any deal.<br />
From the buyers’ view the sellers have not adjusted their price expectations given the<br />
state of the economy, and from the sellers’ perspective the buyers are over emphasis<strong>in</strong>g<br />
the risk. One potential step to try and bridge the gap between the bid and ask<strong>in</strong>g prices<br />
is to structure a deal that shares risk and rewards. From s<strong>in</strong>gle credits to portfolios,<br />
returns may be improved by consider<strong>in</strong>g various alternative structures.<br />
Any <strong>in</strong>tended structure will need to take <strong>in</strong>to consideration the seller’s objective<br />
for the debt sale.<br />
Typically most sellers of debt, especially f<strong>in</strong>ancial <strong>in</strong>stitutions, are motivated by<br />
both the quantitative and qualitative benefits of sell<strong>in</strong>g problem loans:<br />
Depend<strong>in</strong>g on the goals of the seller, and the regulatory environment <strong>in</strong> which the<br />
seller operates, typically three types of sales structures are considered to maximise<br />
the seller’s objectives, as outl<strong>in</strong>ed below.<br />
sell<strong>in</strong>g loans<br />
Quantitative benefits<br />
• Immediate reduction of NPLs <strong>in</strong> a timely<br />
manner – improve NPL position<br />
• Possible ga<strong>in</strong> on disposal for the NPLs<br />
(depend<strong>in</strong>g on provision levels)<br />
• Improve liquidity position of the bank<br />
and capital adequacy position –<br />
possible release of capital and resources<br />
which can be used for other purposes<br />
• Reduction <strong>in</strong> other hold<strong>in</strong>g costs<br />
relat<strong>in</strong>g to NPLs – e.g. ongo<strong>in</strong>g legal fees,<br />
payment of ma<strong>in</strong>tenance on collateral<br />
• M<strong>in</strong>imise and/or better manage future<br />
provision<strong>in</strong>g requirements<br />
Qualitative benefits<br />
• Free up resources of recovery teams<br />
– account officers can be re-assigned<br />
to other areas <strong>in</strong> the bank<br />
• Recovery teams can focus on rema<strong>in</strong><strong>in</strong>g<br />
NPLs that have a better chance of<br />
recovery and maximise recovery potential<br />
• Speed up tim<strong>in</strong>g of recoveries as a<br />
large number of NPL loans can be sold<br />
at one time via a portfolio sale<br />
• Positive market perception –<br />
proactive management of NPLs<br />
may lead to improved rat<strong>in</strong>gs<br />
46
Sales structures maximis<strong>in</strong>g seller’s objectives<br />
Option 1: Outright sale –<br />
typically for cash<br />
Option 2: JV arrangement<br />
Buyer<br />
[Investor]<br />
NPL<br />
Debt Seller<br />
[Bank]<br />
Buyer<br />
[Investor]<br />
NPL<br />
Debt Seller<br />
[Bank]<br />
Cash<br />
Equity<br />
SPV<br />
Cash<br />
Cash<br />
Equity<br />
SPV<br />
Cash<br />
Equity<br />
Option 1: Outright sale<br />
– typically for cash<br />
The first option <strong>in</strong>volves the outright sale<br />
of the debt. Most buyers of debt <strong>in</strong> this<br />
scenario will establish an on-shore entity<br />
or special purpose vehicle (SPV) <strong>in</strong> which<br />
to warehouse the transaction. In fact,<br />
many jurisdictions <strong>in</strong> Asia require an entity<br />
which meets local regulatory requirements,<br />
typically local majority ownership, to be<br />
established for these types of transactions.<br />
In this <strong>in</strong>stance, all economic <strong>in</strong>terest <strong>in</strong> the<br />
credit/portfolio would pass to the SPV and<br />
its ultimate owners. The sell<strong>in</strong>g bank would<br />
not reta<strong>in</strong> any <strong>in</strong>terest <strong>in</strong> the credit/portfolio<br />
although <strong>in</strong> some <strong>in</strong>stances the sell<strong>in</strong>g<br />
bank may be contracted to cont<strong>in</strong>ue<br />
servic<strong>in</strong>g the credit or portfolio.<br />
At present, this is generally the preferred<br />
option of most sell<strong>in</strong>g banks <strong>in</strong> Asia,<br />
particularly for portfolios, as it achieves<br />
the follow<strong>in</strong>g aims:<br />
• A reasonably quick process<br />
• Immediate release of resources<br />
• Immediate de-recognition from<br />
the balance sheet<br />
• Perceived to be transparent transaction.<br />
Investors are also generally <strong>in</strong> favour of<br />
this structure as it provides complete<br />
control over the transaction and allows<br />
for a relatively free hand <strong>in</strong> structur<strong>in</strong>g<br />
the ownership of the SPV.<br />
alongside the buyer. Under this option, the<br />
SPV would acquire the credit/portfolio from<br />
the bank for a comb<strong>in</strong>ation of cash (from<br />
the buyer) and non-cash “contribution”<br />
(the NPLs) from the bank. The economic<br />
<strong>in</strong>terest <strong>in</strong> the portfolio would then be<br />
shared by the equity holders pro rata to<br />
their equity stakes or another method<br />
(e.g. profit shar<strong>in</strong>g) as agreed between the<br />
parties.<br />
Generally the ma<strong>in</strong> reason for choos<strong>in</strong>g this<br />
option is price, especially if a value cannot<br />
be determ<strong>in</strong>ed or the value depends upon<br />
some future event. JV arrangements<br />
are often adopted for real estate f<strong>in</strong>ance<br />
projects or where there may be some<br />
perceived sensitivity <strong>in</strong> relation to the<br />
portfolio, for example the bank wishes<br />
to rema<strong>in</strong> <strong>in</strong>volved and m<strong>in</strong>imise any<br />
negative publicity that may result <strong>in</strong> the<br />
event of an outright sale. Alternatively it<br />
is also a mechanism to give the bank the<br />
ability to <strong>in</strong>crease its return if actual returns<br />
are greater than a buyer’s expectations.<br />
The form of the JV arrangement is at the<br />
absolute discretion of the parties <strong>in</strong>volved<br />
but typically sees certa<strong>in</strong> buyer costs and<br />
return requirements be<strong>in</strong>g met <strong>in</strong> priority to<br />
any return back to the sell<strong>in</strong>g bank. Other<br />
advantages of a JV arrangement <strong>in</strong>clude:<br />
• Ability to engage expert asset managers<br />
to maximise value (whether these<br />
are provided by the bank or the<br />
third party buyer)<br />
Option 2: JV arrangement<br />
The second option <strong>in</strong>volves form<strong>in</strong>g a jo<strong>in</strong>t<br />
venture (JV) between the sell<strong>in</strong>g bank and<br />
the buyer. In this scenario the sell<strong>in</strong>g bank<br />
typically holds an equity stake <strong>in</strong> the SPV<br />
47
Sales structures maximis<strong>in</strong>g seller’s objectives<br />
Option 3: Securitisation<br />
Investors<br />
Investor<br />
servic<strong>in</strong>g<br />
Cash<br />
Trustee<br />
Asset<br />
transfer<br />
SPV<br />
Cash<br />
Servicer<br />
(could be sell<strong>in</strong>g bank)<br />
Sell<strong>in</strong>g bank<br />
• Ability to reta<strong>in</strong> the seller's knowledge,<br />
i.e. the people who have been<br />
manag<strong>in</strong>g the portfolio typically<br />
rema<strong>in</strong> <strong>in</strong>volved and transfer<br />
their knowledge to the buyer<br />
• Flexibility <strong>in</strong> the deal structur<strong>in</strong>g options<br />
• Potential higher returns to the<br />
sell<strong>in</strong>g bank (although these<br />
are not guaranteed).<br />
The ma<strong>in</strong> downside of a JV arrangement<br />
is that it may not achieve derecognition<br />
of the loans <strong>in</strong> the seller’s books, which<br />
is often a key driver of the sale.<br />
Option 3: Securitisation<br />
Securitisation is the process by which<br />
assets with generally predictable cash<br />
flow and similar features are packaged<br />
<strong>in</strong>to <strong>in</strong>terest-bear<strong>in</strong>g securities with<br />
marketable <strong>in</strong>vestment characteristics.<br />
The key to securitisation is the<br />
predictability of cashflows and support<strong>in</strong>g<br />
loan documentation, and history to<br />
verify these cashflows.<br />
Unlike other bulk sales, the focus of the<br />
<strong>in</strong>vestor group <strong>in</strong> this <strong>in</strong>stance is usually<br />
on the rat<strong>in</strong>g of the special purpose<br />
vehicle and the coupon payable.<br />
Loans that typically lend themselves<br />
to securitisation <strong>in</strong>clude:<br />
• Loans with dependable cashflow<br />
streams (e.g. perform<strong>in</strong>g loans,<br />
particularly mortgage/hous<strong>in</strong>g loans)<br />
• Real estate portfolios with<br />
clear cashflow streams<br />
• Loans where loan documentation<br />
is complete and <strong>in</strong> electronic form<br />
allow<strong>in</strong>g easier verification.<br />
Advantages of securitisation <strong>in</strong>clude new<br />
sources of funds for the seller and possible<br />
enhancement of the sell<strong>in</strong>g bank’s ratios.<br />
However the <strong>in</strong>formation needs are high<br />
as underwrit<strong>in</strong>g costs can be significant<br />
and transactions can be time consum<strong>in</strong>g.<br />
Other structur<strong>in</strong>g considerations<br />
While the above description primarily<br />
focuses on sale structures that are typically<br />
adopted by sell<strong>in</strong>g banks, all buyers should<br />
consider the follow<strong>in</strong>g dur<strong>in</strong>g their own<br />
structur<strong>in</strong>g plann<strong>in</strong>g for any acquisition:<br />
• Flexibility to accommodate current<br />
and future bus<strong>in</strong>ess objectives (i.e. an<br />
<strong>in</strong>vestment platform that allows for<br />
various types of <strong>in</strong>vestments and,<br />
if necessary can accommodate<br />
several jo<strong>in</strong>t venture partners)<br />
• Ability to enable a tax efficient exit<br />
• M<strong>in</strong>imise any potential permanent<br />
establishment risk, if desired, for the<br />
<strong>in</strong>vestment vehicle <strong>in</strong> the local country<br />
where the <strong>in</strong>vestments are made<br />
• Analysis of tax efficient structur<strong>in</strong>g for<br />
any management company activities <strong>in</strong><br />
foreign jurisdictions (i.e. representative<br />
office or branch)<br />
• M<strong>in</strong>imise withhold<strong>in</strong>g tax costs<br />
and capital ga<strong>in</strong>s taxes.<br />
48
Perspective<br />
• When choos<strong>in</strong>g structur<strong>in</strong>g options, sellers need to ensure that their<br />
bus<strong>in</strong>ess objectives are facilitated. Transactions <strong>in</strong>volve complex<br />
judgements about bus<strong>in</strong>ess needs, tax and account<strong>in</strong>g rules,<br />
corporate structures and a variety of legal issues.<br />
• Three types of sales structures which can maximise the seller’s<br />
objectives are: outright sale – typically for cash; a jo<strong>in</strong>t venture<br />
agreement; or a securitisation.<br />
• Buyers also need to consider issues such as the structure of their<br />
<strong>in</strong>vestment vehicle and the regulatory and tax considerations<br />
of conduct<strong>in</strong>g the bus<strong>in</strong>ess <strong>in</strong> <strong>Australia</strong>.<br />
• Negotiat<strong>in</strong>g and agree<strong>in</strong>g on the price is the key to clos<strong>in</strong>g the<br />
deal <strong>in</strong> today’s economic climate. One potential step to try and<br />
bridge the gap between the bid and ask<strong>in</strong>g prices is to structure<br />
a deal that shares risk and rewards. This may mean consider<strong>in</strong>g<br />
alternative <strong>in</strong>novative structures.<br />
A structured deal has the ability<br />
to bridge the pric<strong>in</strong>g differential<br />
between buyers and sellers.<br />
Michael McCreadie, PricewaterhouseCoopers<br />
49
8. Tax implications of sell<strong>in</strong>g<br />
and buy<strong>in</strong>g debt<br />
This section expla<strong>in</strong>s the features of the <strong>Australia</strong>n tax<br />
system that are likely to be relevant to a seller or buyer<br />
of distressed assets. However, the follow<strong>in</strong>g po<strong>in</strong>ts<br />
may be helpful to consider at the <strong>in</strong>itial plann<strong>in</strong>g stage:<br />
• <strong>Australia</strong> taxes resident taxpayers on<br />
their worldwide <strong>in</strong>come and capital<br />
ga<strong>in</strong>s, but non-residents only on their<br />
<strong>Australia</strong>n-sourced <strong>in</strong>come and <strong>in</strong><br />
respect of capital ga<strong>in</strong>s, from <strong>Australia</strong>n<br />
land and branch assets<br />
• That said, <strong>Australia</strong>n resident companies<br />
are often exempt from tax on dividends,<br />
and capital ga<strong>in</strong>s <strong>in</strong> respect of 10%<br />
or greater sharehold<strong>in</strong>gs <strong>in</strong> foreign<br />
companies. Much of a companies'<br />
foreign branch <strong>in</strong>come is also<br />
exempt from tax<br />
• The company tax rate is a flat<br />
30% but progressive tax rates for<br />
<strong>in</strong>dividuals reach 46.5% (<strong>in</strong>clud<strong>in</strong>g<br />
a "Medicare Levy" at the standard rate)<br />
• <strong>Australia</strong> imposes 30% withhold<strong>in</strong>g tax<br />
on "unfranked" dividends paid to nonresidents<br />
(although most tax treaties<br />
reduce this rate to 15% or less). There<br />
is no tax on the remittance of branch<br />
profits to a foreign head office<br />
• The <strong>Australia</strong>n "dividend imputation"<br />
system addresses multiple taxation of<br />
company profits by grant<strong>in</strong>g resident<br />
shareholders a credit for any <strong>Australia</strong>n<br />
company tax on the profits from<br />
which dividends are paid<br />
• Non-resident shareholders do not fully<br />
participate <strong>in</strong> the "dividend imputation"<br />
system. Instead, dividends they<br />
receive out of taxed profits are exempt<br />
from withhold<strong>in</strong>g tax. A separate<br />
withhold<strong>in</strong>g tax exemption applies<br />
to "conduit foreign <strong>in</strong>come"<br />
• <strong>Australia</strong> imposes a 10% Goods and<br />
Services Tax (GST), similar to the<br />
Value-Added Tax (VAT) imposed <strong>in</strong><br />
many European and other jurisdictions.<br />
Exports are usually zero-rated. F<strong>in</strong>ancial<br />
supplies are usually <strong>in</strong>put-taxed<br />
• The <strong>Australia</strong>n States and Territories<br />
impose duty on transfers of <strong>Australia</strong>n<br />
land, and some <strong>in</strong>terests <strong>in</strong> entities that<br />
are <strong>Australia</strong>n land-rich. Depend<strong>in</strong>g on<br />
the jurisdiction, the duty will be 4% to<br />
6.75% of the value of the land<br />
• The <strong>Australia</strong>n Capital Territory,<br />
New South Wales and South <strong>Australia</strong><br />
still impose 0.6% duty on transfers<br />
of unlisted shares and units (from<br />
1 July <strong>2009</strong>, 0.3% duty <strong>in</strong> NSW)<br />
• NSW and SA also still impose duty on<br />
most non-residential mortgages at rates<br />
of 0.4% and 0.15% respectively.<br />
50
The taxation consequences from<br />
the acquisition of debt will depend<br />
on a number of factors, <strong>in</strong>clud<strong>in</strong>g<br />
whether the debt is acquired directly<br />
or through an acquisition of shares<br />
<strong>in</strong> a company hold<strong>in</strong>g the debt.<br />
The “Buy Side”<br />
The taxation consequences from the<br />
acquisition of debt will depend on a<br />
number of factors, <strong>in</strong>clud<strong>in</strong>g whether<br />
the debt is acquired directly or through an<br />
acquisition of shares <strong>in</strong> a company hold<strong>in</strong>g<br />
the debt. In the latter case, the taxation<br />
consequences will depend on a number<br />
of additional factors. These taxation<br />
consequences are summarised below<br />
<strong>in</strong> respect of various forms of acquisition<br />
and hold<strong>in</strong>g of the debt after it is acquired.<br />
It should be noted that the comments<br />
below are based on an assumption that<br />
the acquired debt is a “debt <strong>in</strong>terest”<br />
for tax purposes and is not an “equity<br />
<strong>in</strong>terest”. The taxation consequences<br />
will be different for a holder of a debt<br />
<strong>in</strong>strument which is classified as an<br />
“equity <strong>in</strong>terest” for tax purposes.<br />
For example, distributions on an<br />
“equity <strong>in</strong>terest” will be treated <strong>in</strong> a similar<br />
way to dividends from shares, that is they<br />
will be frankable and imputation credits<br />
will be available to the <strong>in</strong>vestor.<br />
Briefly, a “debt <strong>in</strong>terest” is a f<strong>in</strong>anc<strong>in</strong>g<br />
arrangement under which one party has<br />
an effectively non-cont<strong>in</strong>gent obligation to<br />
pay back f<strong>in</strong>ancial benefits of at least the<br />
same value as the amount advanced to<br />
it. This test is complex and its application<br />
will depend on the specific facts<br />
of each arrangement.<br />
Acquisition of debt<br />
An acquisition of debt may be effected by<br />
way of a purchase, transfer, assignment,<br />
novation or a similar transaction. This<br />
guide does not cover acquisitions which<br />
are conditional and part of a larger<br />
arrangement (e.g. securities lend<strong>in</strong>g).<br />
Briefly, an acquisition of debt is similar to<br />
an acquisition of any other asset – the<br />
amount paid for it becomes its “cost”<br />
for tax purposes. If a debt is acquired<br />
cum <strong>in</strong>terest, that is between the coupon<br />
dates, any amount paid to the seller <strong>in</strong><br />
compensation for the accrued <strong>in</strong>terest<br />
is also <strong>in</strong>cluded <strong>in</strong> the cost amount.<br />
The tax “cost” is important, for example,<br />
if the debt is subsequently sold,<br />
the difference between the proceeds<br />
received from the sale and the “cost”<br />
will be <strong>in</strong>cluded <strong>in</strong> assessable <strong>in</strong>come<br />
of the seller or allowed as a deduction<br />
as taxable <strong>in</strong>come or a tax loss.<br />
Where a particular debt is acquired<br />
together with other assets, the<br />
purchase price is allocated between<br />
the assets <strong>in</strong> proportion to their market<br />
values, as determ<strong>in</strong>ed by the parties<br />
or an <strong>in</strong>dependent valuer.<br />
Any expenses <strong>in</strong>curred by the <strong>in</strong>vestor<br />
<strong>in</strong> mak<strong>in</strong>g the acquisition will be subject<br />
to the ord<strong>in</strong>ary deductibility rules.<br />
For example, ongo<strong>in</strong>g expenses of<br />
a revenue character will normally be<br />
deductible, whereas capital expenditure<br />
may be <strong>in</strong>cluded <strong>in</strong> the cost of the acquired<br />
asset (e.g. shares <strong>in</strong> the company hold<strong>in</strong>g<br />
the debt) or deducted over 5 years.<br />
Acquisition of shares of a<br />
company hold<strong>in</strong>g the debt<br />
Instead of acquir<strong>in</strong>g debt directly, the<br />
<strong>in</strong>vestor may acquire shares <strong>in</strong> a company<br />
that holds the debt. In this case, the<br />
taxation consequences will depend<br />
on whether the acquired company<br />
experiences a more than 50% change <strong>in</strong><br />
its shareholders and whether the company<br />
jo<strong>in</strong>s the <strong>in</strong>vestor’s tax consolidated group.<br />
51
More than 50% change <strong>in</strong> shareholders<br />
Broadly, where the acquisition of shares results <strong>in</strong> an<br />
at least a 50% change of the company’s shareholders,<br />
the availability of bad debt deductions <strong>in</strong> respect of<br />
the debt held by the acquired company will depend<br />
on a number of factors.<br />
The change <strong>in</strong> shareholders is determ<strong>in</strong>ed for the<br />
period start<strong>in</strong>g from the date the debt was <strong>in</strong>curred by<br />
the company and ends on the last day of the <strong>in</strong>come<br />
year dur<strong>in</strong>g which the company seeks to claim a bad<br />
debt deduction <strong>in</strong> respect of the debt. If there was a<br />
more than 50% change <strong>in</strong> the ultimate shareholders of<br />
the company, <strong>in</strong> order to claim a bad debt deduction<br />
<strong>in</strong> respect of the debt, the company must carry on<br />
the same bus<strong>in</strong>ess as it was immediately before<br />
the ownership change dur<strong>in</strong>g the <strong>in</strong>come year <strong>in</strong><br />
which the bad debt deduction is claimed.<br />
Example<br />
On 1/7/01, an <strong>in</strong>vestor acquires all shares <strong>in</strong><br />
Company A hold<strong>in</strong>g debt acquired on 1/3/01.<br />
Company A has <strong>in</strong>come year end<strong>in</strong>g on 30 June.<br />
On 1/9/03, Company A ascerta<strong>in</strong>s the debt as<br />
non-recoverable and writes it off for accounts.<br />
Company A did not ma<strong>in</strong>ta<strong>in</strong> the same<br />
shareholders dur<strong>in</strong>g the period from 1/3/01<br />
(when the debt was acquired) to 30/6/04 (the<br />
end of the <strong>in</strong>come year <strong>in</strong> which the bad debt<br />
deduction is claimed). This is because all shares<br />
<strong>in</strong> the company were acquired by the <strong>in</strong>vestor on<br />
1/7/01, result<strong>in</strong>g <strong>in</strong> a 100% shareholder change.<br />
Unless Company A carries on the same<br />
bus<strong>in</strong>ess dur<strong>in</strong>g the entire 02/04 <strong>in</strong>come year<br />
(i.e. from 1/7/03 to 30/6/04) as it was carried<br />
on 30/6/01 (immediately before the ownership<br />
test was failed), no deduction will be available<br />
to Company A for the debt write-off.<br />
The same bus<strong>in</strong>ess test is a strict test and requires<br />
the company to carry on exactly the same bus<strong>in</strong>ess.<br />
The test may be satisfied for immaterial or organic<br />
changes <strong>in</strong> the bus<strong>in</strong>ess.<br />
If the debt is forgiven <strong>in</strong>stead of be<strong>in</strong>g written off,<br />
more complex provisions deal<strong>in</strong>g with unrealised<br />
losses will apply to determ<strong>in</strong>e whether a deduction<br />
<strong>in</strong> respect of a debt is allowed. These provisions<br />
may allow a deduction or capital loss notwithstand<strong>in</strong>g<br />
the company fail<strong>in</strong>g to carry on the same bus<strong>in</strong>ess<br />
(e.g. where a company does not have a net unrealised<br />
loss at the acquisition time) or disallow a capital loss<br />
or deduction even where the same bus<strong>in</strong>ess test has<br />
been satisfied after the acquisition (<strong>in</strong> some cases<br />
where the company leaves a tax consolidated group).<br />
The <strong>in</strong>vestor’s expenses <strong>in</strong> respect of the acquisition<br />
should be <strong>in</strong>cluded <strong>in</strong> the cost of the shares for<br />
tax purposes, unless the <strong>in</strong>vestor is <strong>in</strong> the share<br />
trad<strong>in</strong>g bus<strong>in</strong>ess and the shares are acquired<br />
as part of that bus<strong>in</strong>ess.<br />
Acquisition of shares <strong>in</strong>to<br />
a tax consolidated group<br />
Where the <strong>in</strong>vestor is a member of a tax consolidated<br />
group and acquires all shares <strong>in</strong> a company hold<strong>in</strong>g<br />
the debt, the acquired company will jo<strong>in</strong> the<br />
<strong>in</strong>vestor’s tax consolidated group.<br />
The tax consolidation provisions are highly technical<br />
and it is strongly recommended to seek advice on<br />
the taxation consequences related to consolidation.<br />
Briefly the follow<strong>in</strong>g matters should be considered:<br />
• Tax costs of certa<strong>in</strong> assets of the acquired company<br />
will be “reset”, but tax costs of debts are likely<br />
to be their face values<br />
• If the acquired company has already claimed a bad<br />
debt deduction <strong>in</strong> respect of a debt, no bad debt<br />
deduction will be available after the acquisition,<br />
even where the share price <strong>in</strong>cludes an amount<br />
<strong>in</strong> respect of the written off debt<br />
52
It is expected that the TOFA legislation<br />
will be enacted <strong>in</strong> <strong>2009</strong> which will require<br />
that most large taxpayers recognise <strong>in</strong>terest<br />
<strong>in</strong>come on an accrual basis for tax purposes.<br />
• If the acquisition results <strong>in</strong> a change<br />
<strong>in</strong> more than 50% of shareholders of<br />
the acquired company between the<br />
date the debt was <strong>in</strong>curred and the<br />
acquisition date, the company must<br />
test whether it was carry<strong>in</strong>g on the<br />
same bus<strong>in</strong>ess dur<strong>in</strong>g that time (i.e.<br />
prior to the acquisition). If it did not,<br />
post-acquisition bad debt deductions <strong>in</strong><br />
respect of this debt may not be available<br />
• If the debt is forgiven <strong>in</strong>stead of be<strong>in</strong>g<br />
written off, more complex provisions<br />
deal<strong>in</strong>g with unrealised losses will<br />
apply, as noted above.<br />
Hold<strong>in</strong>g the debt<br />
Once debt is acquired, the <strong>in</strong>vestor will<br />
become entitled to a return from the<br />
debt (e.g. <strong>in</strong>terest), the <strong>in</strong>vestor may sell<br />
or convert the debt, the debt may be<br />
collected or written off as bad. Taxation<br />
consequences from these scenarios<br />
are summarised below.<br />
Interest <strong>in</strong>come<br />
Generally, <strong>in</strong>terest paid by the issuer<br />
of the debt is <strong>in</strong>cluded <strong>in</strong> assessable<br />
<strong>in</strong>come of the holder on a due and<br />
receivable basis (but see the comment<br />
on the Taxation of F<strong>in</strong>ancial Arrangements<br />
(TOFA) rules below).<br />
There are two ma<strong>in</strong> exceptions to this rule:<br />
• The holder is a f<strong>in</strong>ancial <strong>in</strong>stitution,<br />
<strong>in</strong> which case it is required to account<br />
for <strong>in</strong>terest on an accrual basis<br />
• Some debt, if orig<strong>in</strong>ally issued at a<br />
discount or premium, may require<br />
the holder to account for an amortisation<br />
of the discount or premium on an<br />
accruals basis. Accord<strong>in</strong>gly, if the<br />
purchased debt was orig<strong>in</strong>ally issued<br />
at a discount or premium, advice should<br />
be sought on the taxation treatment<br />
of the rema<strong>in</strong><strong>in</strong>g discount or premium.<br />
If the debtor is not able to pay <strong>in</strong>terest<br />
and one of these exceptions applies,<br />
the <strong>in</strong>terest will cont<strong>in</strong>ue to be <strong>in</strong>cluded<br />
<strong>in</strong> the holder’s assessable <strong>in</strong>come even<br />
if no payments are made, unless the<br />
holder and debtor agree to suspend<br />
an accrual of the <strong>in</strong>terest.<br />
If <strong>in</strong>terest is paid by a non-resident,<br />
it may be subject to a foreign withhold<strong>in</strong>g<br />
tax. The <strong>in</strong>vestor may be able to apply that<br />
withhold<strong>in</strong>g tax to reduce its <strong>Australia</strong>n<br />
tax liability for the year <strong>in</strong> which the tax<br />
was paid. In some cases, the debtor may<br />
request from the <strong>in</strong>vestor a certificate<br />
of residency which confirms that the<br />
<strong>in</strong>vestor is a tax resident <strong>in</strong> <strong>Australia</strong>.<br />
These certificates are requested by<br />
some foreign tax authorities to allow<br />
the debtor to apply a lower rate of<br />
withhold<strong>in</strong>g tax and are issued by<br />
the <strong>Australia</strong>n Taxation Office (ATO).<br />
It is expected that the TOFA legislation<br />
will be enacted <strong>in</strong> <strong>2009</strong> which will require<br />
that most large taxpayers recognise<br />
<strong>in</strong>terest <strong>in</strong>come on an accrual basis for tax<br />
purposes. The legislation is expected to<br />
commence on 1 July 2010, but relevant<br />
taxpayers will be able to elect to apply<br />
it to <strong>in</strong>come years (<strong>in</strong>clud<strong>in</strong>g substituted<br />
account<strong>in</strong>g periods) commenc<strong>in</strong>g<br />
on or after 1 July <strong>2009</strong>.<br />
53
The TOFA rules are complex and change the current<br />
taxation treatment of f<strong>in</strong>ancial arrangements, <strong>in</strong>clud<strong>in</strong>g<br />
debts, by prescrib<strong>in</strong>g a number of methods, some of<br />
which are elective, to recognise <strong>in</strong>come or losses from<br />
f<strong>in</strong>ancial arrangements for tax purposes.<br />
Convert<strong>in</strong>g debt<br />
The holder may choose to convert the debt to another<br />
<strong>in</strong>strument, normally equity <strong>in</strong> the issue of the debt,<br />
if the debt agreement allows such a conversion.<br />
Briefly, the tax cost of shares received from the<br />
conversion will be equal to the cost of the debt<br />
and <strong>in</strong>cidental expenses related to the conversion<br />
and no ga<strong>in</strong> or loss will generally arise.<br />
Alternatively, a deduction for the difference between<br />
the value of the received shares and the debt amount<br />
may be allowed to the creditor if the creditor bought<br />
the debt <strong>in</strong> the course of its bus<strong>in</strong>ess of lend<strong>in</strong>g<br />
money. In this case, the tax cost of shares will<br />
be equal to their market value.<br />
Outcomes for creditor if debtor has<br />
difficulties <strong>in</strong> servic<strong>in</strong>g the debt<br />
If the debtor has difficulties <strong>in</strong> servic<strong>in</strong>g the debt,<br />
the follow<strong>in</strong>g outcomes may be possible:<br />
• Payments are below the required payments<br />
– unless the debt agreement and a subsequent<br />
agreement between the debtor and creditor<br />
specifies otherwise, the creditor will be deemed<br />
to receive <strong>in</strong>terest before pr<strong>in</strong>cipal. For example,<br />
where the required payment is A$100 <strong>in</strong>terest<br />
and A$10 pr<strong>in</strong>cipal, but only A$90 payment<br />
is made, the creditor will be required to deem<br />
this payment as <strong>in</strong>terest only.<br />
• Changes to the debt agreement – the parties<br />
may choose to renegotiate the debt agreement<br />
to provide for a change <strong>in</strong> the payment schedule,<br />
etc. These changes may result <strong>in</strong> a debt for<br />
tax purposes be<strong>in</strong>g converted <strong>in</strong>to an “equity<br />
<strong>in</strong>terest”, return from which will be deemed to<br />
be a frankable distribution. Renegotiation of the<br />
debt agreement will require detailed consideration<br />
of the taxation consequences.<br />
• Writ<strong>in</strong>g off all or part of the debt – the holder<br />
may re-assess the recoverability of the debt and<br />
choose to write-off all or part of the debt <strong>in</strong> its<br />
accounts. However, a correspond<strong>in</strong>g deduction<br />
will only be available where:<br />
− The debt exists at the time of the writ<strong>in</strong>g off<br />
(i.e. it has not been ext<strong>in</strong>guished, etc)<br />
− The debt has actually gone “bad”, that is,<br />
for example, reasonable recovery attempts<br />
have failed, the debtor is <strong>in</strong> liquidation,<br />
etc. A mere expectation of a default<br />
is not sufficient for a deduction<br />
− The holder bought the debt <strong>in</strong> the ord<strong>in</strong>ary<br />
course of the holder’s bus<strong>in</strong>ess of lend<strong>in</strong>g money.<br />
The deduction is limited by the amount the debt<br />
was bought for<br />
− Forgiveness of accrued <strong>in</strong>terest <strong>in</strong>curred after<br />
the purchase will give rise to a deduction<br />
only if the <strong>in</strong>terest has been <strong>in</strong>cluded <strong>in</strong> the<br />
holder’s assessable <strong>in</strong>come or if <strong>in</strong>terest can<br />
be classified as debt <strong>in</strong> respect of money lent by<br />
the holder <strong>in</strong> the course of the holder’s bus<strong>in</strong>ess<br />
of lend<strong>in</strong>g money<br />
− See comments above regard<strong>in</strong>g when the debt<br />
is held by a company purchased by the <strong>in</strong>vestor<br />
− Future recoupments of a debt written<br />
off for tax purposes will be <strong>in</strong>cluded <strong>in</strong><br />
the holder’s assessable <strong>in</strong>come.<br />
• Legally forgiv<strong>in</strong>g the debt – the creditor may<br />
choose to legally forgive all or part of the debt,<br />
therefore fully or partially discharg<strong>in</strong>g the debtor.<br />
A discharge is likely to give rise to a deduction<br />
or a capital loss for the holder; however, the<br />
exact amount of the deduction will depend on<br />
the specific facts of each case. Further, the<br />
forgiveness may also result <strong>in</strong> taxation implications<br />
for the debtor and/or debtor’s group entities<br />
under the commercial debt forgiveness rules.<br />
54
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Met laore feugue consequi elissim dolendi<br />
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laore feugue consequi elissim dolendions.<br />
Incidental expenditures of the holder<br />
• Broadly, the purchaser and holder of the debt<br />
should be entitled to a deduction for <strong>in</strong>cidental<br />
expenditures <strong>in</strong>curred <strong>in</strong> acquir<strong>in</strong>g and hold<strong>in</strong>g<br />
the debt as those expenditures are <strong>in</strong>curred.<br />
This will <strong>in</strong>clude legal fees, factor<strong>in</strong>g fees, etc.<br />
However, where an expenditure is of a capital<br />
nature, for example, due diligence fees <strong>in</strong> respect<br />
of an acquisition of a bus<strong>in</strong>ess together with debt,<br />
the deductibility may be restricted by <strong>in</strong>clud<strong>in</strong>g<br />
the expenses <strong>in</strong> the tax cost of certa<strong>in</strong> assets<br />
or allow<strong>in</strong>g a deduction over 5 years.<br />
Overseas matters<br />
Generally, the above rules apply to debts where a<br />
debtor or creditor is a non-resident. However, the<br />
follow<strong>in</strong>g considerations should be kept <strong>in</strong> m<strong>in</strong>d:<br />
• Where the debtor is a non-resident, <strong>in</strong>terest<br />
payments and payments <strong>in</strong> the nature of<br />
<strong>in</strong>terest (e.g. discounts) may be subject to<br />
a foreign withhold<strong>in</strong>g tax. The creditor may<br />
reduce its <strong>Australia</strong>n tax by the foreign tax<br />
withheld from <strong>in</strong>terest<br />
• Where the debt is held by a foreign branch of the<br />
<strong>Australia</strong>n holder and <strong>in</strong>come of the branch is<br />
exempt from <strong>Australia</strong>n tax, no bad debt deduction<br />
<strong>in</strong> respect of the debt will be available, even<br />
though legally the debt is held by an <strong>Australia</strong>n<br />
taxpayer and other conditions for the bad debt<br />
deduction are satisfied<br />
• Any transfers of the debt between <strong>in</strong>ternational<br />
related parties must be on arm’s length terms<br />
• If the debt is held by an <strong>Australia</strong>n branch of a<br />
non-resident, the rules above will generally apply<br />
to the branch. However, if the debt is held by a<br />
non-resident not through a branch <strong>in</strong> <strong>Australia</strong>,<br />
the acquisition, hold<strong>in</strong>g and disposal of the debt<br />
should not have <strong>Australia</strong>n taxation consequences<br />
for the non-residents<br />
• Debt may also be acquired by a trustee of a trust.<br />
If a trust is a fixed trust, that is its beneficiaries<br />
are entitled to a fixed share of the trust’s <strong>in</strong>come<br />
(e.g. a unit trust), it is the beneficiaries and not the<br />
trustee who should generally be assessed for tax<br />
<strong>in</strong> respect of their entitlement.<br />
Where all or some of the beneficiaries are nonresidents,<br />
and the trust qualifies as a “managed<br />
<strong>in</strong>vestment scheme”, <strong>in</strong>come from collection and<br />
disposal of <strong>Australia</strong>n debts (but not <strong>in</strong>terest) to which<br />
foreign beneficiaries are entitled to, may be subject<br />
to a reduced rate of f<strong>in</strong>al <strong>Australia</strong>n withhold<strong>in</strong>g tax.<br />
<strong>Australia</strong>n stamp duty<br />
<strong>Australia</strong>n stamp duty is a State-based tax<br />
imposed on transactions and legal documents.<br />
There are eight different sets of rules govern<strong>in</strong>g<br />
stamp duty <strong>in</strong> <strong>Australia</strong>.<br />
There is no logic or uniformity to the various regimes.<br />
However, outl<strong>in</strong>ed below are some of the broad stamp<br />
duty issues which will need to be considered by the<br />
buyer of distressed assets, as the obligations to pay<br />
duty generally fall on the buyer. Given the complexity<br />
and differences <strong>in</strong> the rules for each jurisdiction,<br />
the actual stamp duty exposure will depend on<br />
the circumstances of the particular transaction.<br />
• Transfer duty is imposed on the acquisition<br />
of assets located <strong>in</strong> <strong>Australia</strong>. Assets which<br />
are subject to duty, <strong>in</strong> some or all jurisdictions,<br />
<strong>in</strong>clude land and build<strong>in</strong>gs, bus<strong>in</strong>ess assets<br />
(e.g. plant and equipment, goodwill, <strong>in</strong>tellectual<br />
property, trade debts etc.). The rates of duty<br />
vary <strong>in</strong> each jurisdiction and among jurisdictions<br />
but can be as high as 6.75%. Duty is calculated<br />
on the greater of the market value of the asset<br />
and the consideration paid (<strong>in</strong>clusive of GST).<br />
Accord<strong>in</strong>gly, the stamp duty exposure on the<br />
acquisition of distressed assets will depend on the<br />
nature of the distressed assets and their location.<br />
55
• Transfer duty may also apply to any subsequent<br />
transfer of the assets between entities of the buyer’s<br />
own corporate group. However, any <strong>in</strong>tra-group<br />
transfer may qualify for corporate reconstruction<br />
relief but formal application for relief is required<br />
to be made.<br />
• Where the distressed assets <strong>in</strong>clude shares<br />
or units, marketable securities duty is payable<br />
<strong>in</strong> New South Wales, the <strong>Australia</strong>n Capital Territory<br />
and South <strong>Australia</strong> on the transfer of shares<br />
<strong>in</strong> unlisted companies and unit trusts connected<br />
with those jurisdictions. Marketable securities<br />
duty is imposed at 0.6% (or 0.3% <strong>in</strong> South <strong>Australia</strong><br />
from 1 July <strong>2009</strong>) on the higher of the market value<br />
of the shares/units and the consideration paid.<br />
• The acquisition of <strong>in</strong>terests <strong>in</strong> entities which hold<br />
any land assets located <strong>in</strong> <strong>Australia</strong>, either directly<br />
or <strong>in</strong>directly or on a consolidated basis, could<br />
also attract land rich or land holder duty. Land<br />
rich or landholder duty is imposed at transfer duty<br />
rates (i.e. up to 6.75%) on the market value of the<br />
underly<strong>in</strong>g land assets (although <strong>in</strong> one jurisdiction,<br />
duty is imposed on both land and chattels). Broadly,<br />
these provisions effectively deem an acquisition<br />
of an <strong>in</strong>terest <strong>in</strong> the entity as a direct acquisition<br />
of an <strong>in</strong>terest <strong>in</strong> the land assets held by the entity<br />
or its associated entities.<br />
• In Queensland and South <strong>Australia</strong>, there are<br />
“trust look-through” provisions that need to be<br />
considered if units <strong>in</strong> unlisted unit trusts are part of<br />
the distressed assets. These “trust look-through”<br />
provisions operate to treat deal<strong>in</strong>gs <strong>in</strong> the units as<br />
deal<strong>in</strong>gs <strong>in</strong> the underly<strong>in</strong>g assets of the trust located<br />
<strong>in</strong> South <strong>Australia</strong> or Queensland and duty is<br />
imposed at transfer duty rates on those assets that<br />
are “dutiable property” located <strong>in</strong> those jurisdictions.<br />
• If a buyer borrows or f<strong>in</strong>ances the acquisition<br />
of distressed assets through secured lend<strong>in</strong>g<br />
arrangements, mortgage duty is payable <strong>in</strong><br />
New South Wales and South <strong>Australia</strong> on any<br />
mortgages and charges relat<strong>in</strong>g to assets<br />
located <strong>in</strong> these jurisdictions. Mortgage duty is<br />
imposed at the rate of 0.4% (<strong>in</strong> NSW) and 0.15%<br />
(<strong>in</strong> South <strong>Australia</strong>) on the amount secured<br />
by the mortgages.<br />
• If any leases of real property are entered <strong>in</strong>to where<br />
a premium is paid for the grant<strong>in</strong>g of the lease,<br />
transfer duty may be payable.<br />
GST<br />
The GST treatment of the supply of distressed assets<br />
will be determ<strong>in</strong>ed by the seller. In general, the supply<br />
of distressed assets by a GST-registered seller<br />
will be a taxable supply subject to GST unless the<br />
supply is a GST-free supply (e.g. a “go<strong>in</strong>g concern”)<br />
or an <strong>in</strong>put taxed supply (e.g. f<strong>in</strong>ancial supplies).<br />
56
The disposal of distressed assets can have<br />
a number of <strong>in</strong>come tax consequences<br />
for the seller. Any ga<strong>in</strong> or loss from a<br />
f<strong>in</strong>ancial asset (e.g. loan) will generally<br />
be assessable or deductible.<br />
GST on the assets<br />
Where the buyer <strong>in</strong>curs GST on the acquisition<br />
of distressed assets, the buyer will be entitled<br />
to recover the GST <strong>in</strong>curred provided:<br />
• it is registered for GST<br />
• the assets will not be used to make <strong>in</strong>put taxed<br />
supplies or are not for private use<br />
• it holds a valid tax <strong>in</strong>voice.<br />
In circumstances where the buyer <strong>in</strong>curs GST on<br />
distressed assets and the assets are subsequently<br />
used to make <strong>in</strong>put taxed supplies, the buyer<br />
will not be entitled to recover the GST <strong>in</strong>curred<br />
on the acquisition.<br />
Where the distressed assets are used to make both<br />
<strong>in</strong>put taxed supplies and either taxable or GST-free<br />
supplies, the GST <strong>in</strong>curred may be apportioned on a<br />
“fair and reasonable” basis and the proportion of the<br />
GST <strong>in</strong>curred on the assets relat<strong>in</strong>g to the subsequent<br />
taxable or GST-free supplies may be recovered.<br />
Where the distressed assets are acquired as a<br />
GST-free supply of a go<strong>in</strong>g concern and the buyer<br />
subsequently uses the assets to make <strong>in</strong>put taxed<br />
supplies, the buyer will be required to make an<br />
adjustment <strong>in</strong> relation to GST. The amount of the<br />
adjustment payable to the ATO will be 10% of<br />
the proportion of the purchase price that relates<br />
to mak<strong>in</strong>g <strong>in</strong>put taxed supplies.<br />
Please note that where the buyer acquires property<br />
under the marg<strong>in</strong> scheme, it will not be entitled<br />
to claim any GST <strong>in</strong>curred on the acquisition<br />
of the property as an <strong>in</strong>put tax credit.<br />
GST on transaction costs<br />
Where the distressed assets are <strong>in</strong>put taxed f<strong>in</strong>ancial<br />
supplies or the distressed assets are used for <strong>in</strong>put<br />
taxed supplies, any GST <strong>in</strong>curred on professional<br />
costs relat<strong>in</strong>g to the acquisition of the distressed<br />
assets will generally not be recoverable <strong>in</strong> full. In these<br />
circumstances, the buyer should determ<strong>in</strong>e whether<br />
it exceeds the f<strong>in</strong>ancial acquisition threshold and<br />
whether it will be entitled to reduced <strong>in</strong>put tax credits.<br />
The “Sell Side”<br />
Special rules for f<strong>in</strong>ancial arrangements<br />
The disposal of distressed assets can have a number<br />
of <strong>in</strong>come tax consequences for the seller. Any ga<strong>in</strong><br />
or loss from a f<strong>in</strong>ancial asset (e.g. loan) will generally<br />
be assessable or deductible. If the asset carries a<br />
deferred return, the disposal of the security may<br />
trigger a balanc<strong>in</strong>g adjustment to take <strong>in</strong>to account<br />
any part of the deferred return which has previously<br />
been <strong>in</strong>cluded <strong>in</strong> the seller’s assessable <strong>in</strong>come.<br />
A deduction for a loss made on a f<strong>in</strong>ancial asset may<br />
be denied <strong>in</strong> certa<strong>in</strong> circumstances where the loss is<br />
capital <strong>in</strong> nature and the f<strong>in</strong>ancial asset is disposed of<br />
because of the possibility of the issuer default<strong>in</strong>g.<br />
In the case of assets other than f<strong>in</strong>ancial assets<br />
(e.g. ownership <strong>in</strong>terests <strong>in</strong> an entity that owns<br />
distressed assets), losses made on assets held on<br />
revenue account will generally be deductible, whereas<br />
losses on assets held on capital account will only be<br />
deductible aga<strong>in</strong>st capital ga<strong>in</strong>s or can be carried<br />
forward to be offset aga<strong>in</strong>st future capital ga<strong>in</strong>s.<br />
Where the ownership <strong>in</strong>terest is an equity <strong>in</strong>terest <strong>in</strong><br />
an <strong>Australia</strong>n company, care will need to be taken<br />
that the disposal does not result <strong>in</strong> the denial of the<br />
benefit of any frank<strong>in</strong>g credits attached to dividends<br />
which may be paid to the seller.<br />
Assets denom<strong>in</strong>ated <strong>in</strong> foreign currency<br />
Where the distressed asset or ownership <strong>in</strong>terest is<br />
denom<strong>in</strong>ated <strong>in</strong> foreign currency, ga<strong>in</strong>s or losses which<br />
arise as a result of fluctuat<strong>in</strong>g exchange rates between<br />
the date of disposal and the date of payment are<br />
generally assessable or deductible, respectively.<br />
57
New tax-tim<strong>in</strong>g rules<br />
New TOFA tax-tim<strong>in</strong>g rules will apply to <strong>in</strong>come<br />
years commenc<strong>in</strong>g on or after 1 July 2010<br />
(or 1 July <strong>2009</strong>, if a taxpayer elects). The new rules<br />
will effectively remove the capital/revenue dist<strong>in</strong>ction<br />
for eligible taxpayers and allow them to rely on<br />
their f<strong>in</strong>ancial accounts <strong>in</strong> determ<strong>in</strong><strong>in</strong>g their tax<br />
liability if they so elect.<br />
If the new rules apply to the seller of a distressed<br />
asset, the disposal of the distressed asset will<br />
generally result <strong>in</strong> a balanc<strong>in</strong>g adjustment which<br />
will require the seller to recognise an assessable<br />
ga<strong>in</strong> or a deductible loss. The new rules will<br />
not apply to the disposal of an equity <strong>in</strong>terest<br />
(e.g. ord<strong>in</strong>ary shares) if the seller has not elected<br />
to rely on their f<strong>in</strong>ancial accounts for tax purposes.<br />
Debt restructur<strong>in</strong>g<br />
In general, the sale of distressed assets by an entity,<br />
likely to be undertaken to raise funds to enable<br />
debts to be repaid, will give rise to either ga<strong>in</strong>s or<br />
losses for <strong>in</strong>come tax purposes. Any ga<strong>in</strong>s made<br />
on the sale of distressed assets will be assessable.<br />
Losses made on the sale of distressed assets will<br />
generally be deductible. Losses made on the sale<br />
of non-depreciat<strong>in</strong>g assets held on capital account<br />
can only be deducted aga<strong>in</strong>st capital ga<strong>in</strong>s.<br />
Entities should be aware, however, that <strong>in</strong> certa<strong>in</strong><br />
circumstances amounts may be <strong>in</strong>cluded <strong>in</strong><br />
assessable <strong>in</strong>come where assets have been acquired<br />
under limited recourse f<strong>in</strong>anc<strong>in</strong>g arrangements<br />
and, upon term<strong>in</strong>ation of that debt (which may be<br />
expected to occur <strong>in</strong> conjunction with the sale of<br />
the asset), the amount ow<strong>in</strong>g is not fully repaid.<br />
Broadly, assessable amounts may arise where<br />
capital allowance deductions (such as depreciation)<br />
are considered to have been claimed excessively<br />
over the life of the asset.<br />
Further, amounts may also be <strong>in</strong>cluded <strong>in</strong><br />
assessable <strong>in</strong>come <strong>in</strong> respect of the sale of leased<br />
plant by an entity, aga<strong>in</strong> <strong>in</strong> circumstances where<br />
depreciation has been deducted <strong>in</strong> respect of the<br />
asset. Broadly, this may occur where a liability of the<br />
entity is reduced as a result of the sale of the asset,<br />
for example, on the entity receiv<strong>in</strong>g a benefit <strong>in</strong> the<br />
form of be<strong>in</strong>g relieved of a debt.<br />
It is important to consider the tax impact of these<br />
“recoupment” type provisions when determ<strong>in</strong><strong>in</strong>g how<br />
best to deal with distressed assets, as their application<br />
may result <strong>in</strong> an entity receiv<strong>in</strong>g significantly less<br />
value than first anticipated on the sale of an asset,<br />
therefore potentially affect<strong>in</strong>g the entity’s course<br />
of deal<strong>in</strong>g with that asset.<br />
Entities with distressed assets may also look to<br />
restructure their debt through debt defeasance<br />
arrangements. Such arrangements allow a debtor,<br />
with a liability to repay a loan at some future date,<br />
to pay a third party a reduced amount (e.g, the current<br />
present value of the future liability) <strong>in</strong> consideration<br />
of the third party assum<strong>in</strong>g the liability to repay the<br />
amount owed by the debtor when it becomes due.<br />
This may <strong>in</strong>clude situations where the distressed<br />
assets are sold to f<strong>in</strong>ance the up-front payment<br />
to the third party.<br />
With the exception of f<strong>in</strong>ance entities, sav<strong>in</strong>gs made<br />
by an entity under debt defeasance arrangements<br />
will typically not be treated as ord<strong>in</strong>ary <strong>in</strong>come,<br />
but are likely to fall for consideration and give rise<br />
to consequences under the CGT provisions.<br />
In circumstances where distressed assets<br />
are transferred directly by an entity to discharge<br />
a debt, tax implications under the commercial debt<br />
forgiveness provisions may also arise, depend<strong>in</strong>g<br />
on the market value of the assets and the market<br />
value of the debt at the time the debt is ext<strong>in</strong>guished.<br />
Debt may also be restructured via the deal<strong>in</strong>g<br />
with distressed assets under sale and leaseback<br />
or hire purchase type arrangements but entities<br />
should also seek to confirm the tax implications<br />
<strong>in</strong> advance of enter<strong>in</strong>g <strong>in</strong>to such arrangements.<br />
For example, <strong>in</strong> broad terms, the ability of a lessee<br />
or hirer to obta<strong>in</strong> depreciation deductions <strong>in</strong> respect<br />
of the assets is likely to depend on the existence<br />
of a right, or obligation, to purchase the asset at<br />
the end of the term of the arrangement.<br />
58
The new tax-tim<strong>in</strong>g rules will effectively<br />
remove the capital/revenue dist<strong>in</strong>ction for<br />
eligible taxpayers and allow them to rely<br />
on their f<strong>in</strong>ancial accounts <strong>in</strong> determ<strong>in</strong><strong>in</strong>g<br />
their tax liability if they so elect.<br />
Equity restructur<strong>in</strong>g<br />
Sell<strong>in</strong>g a subsidiary member<br />
of a consolidated group<br />
Where the shares of a subsidiary member of a<br />
consolidated group are sold, the subsidiary member<br />
will leave the consolidated group (leav<strong>in</strong>g subsidiary).<br />
This will trigger a number of tax consequences for the<br />
head company of the consolidated group as follows.<br />
• The head company will be required to recalculate<br />
the cost base of the shares of the leav<strong>in</strong>g subsidiary.<br />
The cost base is broadly equal to the cost base of<br />
the assets that the leav<strong>in</strong>g subsidiary takes with it<br />
m<strong>in</strong>us the value of the leav<strong>in</strong>g subsidiary's liabilities.<br />
• Us<strong>in</strong>g this recalculated cost base, the head<br />
company will be required to determ<strong>in</strong>e whether<br />
it has made a capital ga<strong>in</strong> or a capital loss<br />
from the share sale.<br />
• Where the leav<strong>in</strong>g subsidiary's liabilities exceed<br />
the cost base of its assets, the head company will<br />
make a capital ga<strong>in</strong> under CGT event L5 equal<br />
to that excess.<br />
• For the leav<strong>in</strong>g subsidiary, leav<strong>in</strong>g a consolidated<br />
group may trigger an obligation to make a<br />
payment to the head company under a tax shar<strong>in</strong>g<br />
agreement to enable the subsidiary member<br />
to leave the consolidated group clear of any jo<strong>in</strong>t<br />
and several liability to pay the group's tax liabilities.<br />
In addition, any tax losses, frank<strong>in</strong>g credits or other<br />
tax attributes of the consolidated group will rema<strong>in</strong><br />
with the head company and will not be passed<br />
to the leav<strong>in</strong>g subsidiary.<br />
Sell<strong>in</strong>g a foreign subsidiary<br />
Where the shares of a foreign subsidiary are sold, a<br />
capital ga<strong>in</strong> or capital loss will be triggered. However,<br />
where the shares were held by an <strong>Australia</strong>n resident<br />
company that held a direct vot<strong>in</strong>g percentage of at<br />
least 10% <strong>in</strong> the foreign company for a cont<strong>in</strong>uous<br />
period of at least 12 months <strong>in</strong> the 2 years before the<br />
sale, the capital ga<strong>in</strong> or capital loss can be reduced.<br />
The capital ga<strong>in</strong> or capital loss is reduced by<br />
the foreign company’s “active foreign bus<strong>in</strong>ess<br />
percentage”. The “active foreign bus<strong>in</strong>ess<br />
percentage” is the value of the foreign company’s<br />
active bus<strong>in</strong>ess assets as a percentage of the<br />
value of the foreign company’s total assets.<br />
The <strong>Australia</strong>n resident company can choose to value<br />
the foreign company’s assets at either book value or<br />
market value, but if either of those methods cannot<br />
be used, or if no choice is made, a default method<br />
applies under which capital ga<strong>in</strong>s are fully taxable and<br />
capital losses are reduced to nil. If the “active foreign<br />
bus<strong>in</strong>ess percentage” is less than 10%, it is rounded<br />
down to zero (so that a capital ga<strong>in</strong> becomes fully<br />
taxable) and if it is greater than 90%, it is rounded<br />
up to 100% (so that a capital ga<strong>in</strong> is reduced to zero).<br />
59
Pay<strong>in</strong>g for others’ mistakes<br />
The disposal of distressed assets can have <strong>in</strong>come<br />
tax consequences for parties beyond the seller where<br />
there is a certa<strong>in</strong> type of fiduciary relationship between<br />
the seller and a third party <strong>in</strong> particular circumstances.<br />
Such third parties <strong>in</strong>clude agents, trustees, liquidators,<br />
receivers and directors of the seller.<br />
Under special rules which can apply, such a third<br />
party may become personally liable to discharge<br />
certa<strong>in</strong> tax liabilities of the seller (<strong>in</strong> the case of agents,<br />
trustees, liquidators and receivers), be jo<strong>in</strong>tly and<br />
severally liable to pay adm<strong>in</strong>istrative penalties (<strong>in</strong> the<br />
case of company directors where a sell<strong>in</strong>g company<br />
has failed to comply with a tax law) or be deemed to<br />
have committed a taxation offence <strong>in</strong> relation to an<br />
act or omission done by the company (<strong>in</strong> the case of<br />
company directors where a company has committed<br />
a taxation offence).<br />
Indirect tax<br />
The GST treatment of supplies of distressed assets<br />
will depend on a number of factors <strong>in</strong>clud<strong>in</strong>g:<br />
• The legal capacity of the seller<br />
• The character of the distressed asset be<strong>in</strong>g supplied<br />
• The entity responsible for the GST consequences<br />
of the supply<br />
• Whether the assets be<strong>in</strong>g supplied would otherwise<br />
be GST-free or <strong>in</strong>put taxed under the GST Law.<br />
In general, the supply of a distressed asset by a<br />
GST-registered seller will be a taxable supply subject<br />
to GST unless the supply is a GST-free supply<br />
(e.g. a "go<strong>in</strong>g concern") or an <strong>in</strong>put taxed supply<br />
(e.g. f<strong>in</strong>ancial supplies). For each supply, the seller<br />
will also need to consider whether an adjustment<br />
is required for GST <strong>in</strong>put tax credits claimed at the<br />
time the asset was acquired.<br />
Difficulties can and do arise for GST purposes where<br />
the seller is a representative (e.g. adm<strong>in</strong>istrator,<br />
receiver, liquidator) of an "<strong>in</strong>capacitated entity"<br />
(e.g. an entity that is <strong>in</strong> liquidation or receivership).<br />
The ATO takes the view that a representative of an<br />
<strong>in</strong>capacitated entity will be liable for GST, entitled to<br />
GST <strong>in</strong>put tax credits, and has adjustments, <strong>in</strong> respect<br />
of supplies and acquisitions it makes from the date<br />
it is appo<strong>in</strong>ted as representative of the <strong>in</strong>capacitated<br />
entity. The <strong>in</strong>capacitated entity will cont<strong>in</strong>ue to be liable<br />
for GST on supplies and entitled to GST <strong>in</strong>put tax<br />
credits on acquisitions made prior to the appo<strong>in</strong>tment<br />
of the representative, subject to an exception<br />
relat<strong>in</strong>g to adjustments.<br />
Further, where a mortgagee <strong>in</strong> possession sells<br />
property <strong>in</strong> satisfaction of a debt owed by a debtor,<br />
the mortgagee <strong>in</strong> possession will be responsible<br />
for the GST consequences of the supply.<br />
Where the asset be<strong>in</strong>g supplied is real property,<br />
the characteristics of the property will determ<strong>in</strong>e<br />
whether it is a taxable, GST-free or <strong>in</strong>put taxed<br />
supply of real property. If the real property be<strong>in</strong>g<br />
supplied is taxable, the seller should consider<br />
whether the "marg<strong>in</strong> scheme" will apply to the supply.<br />
60
Perspective<br />
• Sell<strong>in</strong>g or buy<strong>in</strong>g distressed assets <strong>in</strong> <strong>Australia</strong> <strong>in</strong>volves<br />
comply<strong>in</strong>g with a complex range of taxation requirements<br />
and record keep<strong>in</strong>g responsibilities.<br />
• Both buyers or sellers need to consider the tax implications of<br />
the <strong>in</strong>vestment vehicle and the structure of the transaction at an<br />
early stage to m<strong>in</strong>imise the risk of unanticipated tax exposures<br />
and to help maximise taxation opportunities.<br />
• All aspects of taxation need to be considered <strong>in</strong>clud<strong>in</strong>g<br />
<strong>in</strong>come tax, capital ga<strong>in</strong>s tax, withhold<strong>in</strong>g tax, GST and stamp duty.<br />
• Foreign <strong>in</strong>vestors also need to consider their <strong>in</strong>ternational<br />
tax arrangements.<br />
61
Appendix A –<br />
Economic outlook<br />
Global economic outlook<br />
The current global economic landscape bears little<br />
resemblance to this time last year. With <strong>in</strong> excess of<br />
US$1 trillion lost <strong>in</strong> write-downs to date, and the IMF<br />
revis<strong>in</strong>g forecasts of total losses upwards to US$2.2 trillion,<br />
it appears that a return to normality is still a way off. What<br />
we are currently witness<strong>in</strong>g is a massive adjustment <strong>in</strong> the<br />
global economy, from an environment of cheap and plentiful<br />
debt to one of debt scarcity. The impact of this adjustment<br />
has now flowed from Wall Street to the ma<strong>in</strong> street economy.<br />
The IMF has subsequently slashed its<br />
average global growth forecasts, down<br />
from 1.75% <strong>in</strong> November 2008 to 0.5%<br />
by January <strong>2009</strong>. But averages hide the<br />
sizable diversity <strong>in</strong> growth rates between<br />
countries. The economies of developed<br />
nations are forecast to contract by<br />
an average 2.0% dur<strong>in</strong>g <strong>2009</strong>. Much<br />
therefore h<strong>in</strong>ges on Ch<strong>in</strong>a and India, the<br />
world’s 3rd and 12th largest economies<br />
respectively. The IMF forecasts 6.7% and<br />
5.1% respective annual growth for<br />
these economies, hence the positive<br />
global average. However even these<br />
forecasts have been revised downwards<br />
over the course of the last four months,<br />
with much now rest<strong>in</strong>g on their ability to<br />
show agility <strong>in</strong> develop<strong>in</strong>g new export<br />
markets and grow<strong>in</strong>g their massive,<br />
but underdeveloped, domestic economies.<br />
<strong>Australia</strong>n<br />
economic outlook<br />
The outlook for the <strong>Australia</strong>n economy<br />
has deteriorated <strong>in</strong> l<strong>in</strong>e with global trends<br />
and now faces the prospect of enter<strong>in</strong>g<br />
a recession <strong>in</strong> the first half of <strong>2009</strong>.<br />
Consensus has moved away from a soft<br />
land<strong>in</strong>g to a rockier land<strong>in</strong>g and periods<br />
of susta<strong>in</strong>ed distress for certa<strong>in</strong> <strong>in</strong>dustries.<br />
Our <strong>Australia</strong>n Economic Outlook sees<br />
GDP growth slow<strong>in</strong>g from the 2.1%<br />
dur<strong>in</strong>g 2008 to between 0 - 0.5%<br />
dur<strong>in</strong>g <strong>2009</strong>. Therefore, <strong>Australia</strong>’s<br />
position is relatively bright <strong>in</strong> relation to<br />
other developed countries. The prime<br />
reason for this is a stronger f<strong>in</strong>ancial<br />
sector that has resulted from superior<br />
credit policies and risk management<br />
strategies. The recent Government<br />
move to guarantee bank deposits<br />
has further strengthened the sector<br />
and ensured that confidence rema<strong>in</strong>s.<br />
62
However, the fortunes of the <strong>Australia</strong>n<br />
economy are still deeply entw<strong>in</strong>ed<br />
with <strong>in</strong>ternational factors <strong>in</strong>clud<strong>in</strong>g:<br />
• The negative f<strong>in</strong>ancial contagion effect<br />
where assets and <strong>in</strong>dustries <strong>in</strong> <strong>Australia</strong><br />
become negatively affected by decl<strong>in</strong>es<br />
<strong>in</strong> asset values which orig<strong>in</strong>ated<br />
<strong>in</strong> the US<br />
• A soften<strong>in</strong>g <strong>in</strong> commodity prices,<br />
accompanied by a sharp slow<strong>in</strong>g <strong>in</strong><br />
demand has seen <strong>Australia</strong>n resources<br />
fac<strong>in</strong>g both a contraction <strong>in</strong> the value<br />
and volumes of exports. The results<br />
have been m<strong>in</strong>e closures, deferment<br />
of <strong>in</strong>frastructure and asset sales<br />
• Health of top export markets, Japan,<br />
Ch<strong>in</strong>a and South Korea which together<br />
account for 39% of total exports.<br />
The Japanese and South Korean<br />
economies have been two of the<br />
hardest hit, while the performance<br />
of the Ch<strong>in</strong>ese economy is be<strong>in</strong>g<br />
keenly watched from around the<br />
world. Susta<strong>in</strong>ed contractions <strong>in</strong><br />
these markets, imply<strong>in</strong>g reduced<br />
demand for <strong>Australia</strong>n commodities,<br />
will hurt <strong>Australia</strong>n bus<strong>in</strong>esses and<br />
stra<strong>in</strong> <strong>Australia</strong>’s terms of trade<br />
On the domestic front, a number<br />
of factors <strong>in</strong>fluenc<strong>in</strong>g our outlook<br />
for the com<strong>in</strong>g period <strong>in</strong>clude:<br />
• A slow rise <strong>in</strong> unemployment towards<br />
6 – 7% (currently 4.5%), affect<strong>in</strong>g<br />
all sectors and States<br />
• A weaken<strong>in</strong>g <strong>Australia</strong>n property<br />
market with more suburbs and market<br />
segments experienc<strong>in</strong>g decl<strong>in</strong>es.<br />
However, our property prices are<br />
traditionally sticky on the downside,<br />
most cities have hous<strong>in</strong>g demand<br />
exceed<strong>in</strong>g new supply, and the recent<br />
Federal stimulus package conta<strong>in</strong>ed<br />
an <strong>in</strong>crease <strong>in</strong> new home owner grants<br />
that could buoy demand<br />
• Fall<strong>in</strong>g levels of <strong>in</strong>flation as petrol prices<br />
soften and consumer confidence<br />
levels rema<strong>in</strong> low<br />
• Increases <strong>in</strong> household sav<strong>in</strong>gs rates,<br />
as spooked consumers choose to pay<br />
down debt and lock away wealth as<br />
the short-medium term outlook rema<strong>in</strong>s<br />
uncerta<strong>in</strong>. This has the important side<br />
effect of blunt<strong>in</strong>g the effectiveness<br />
of fiscal stimulus packages designed<br />
to boost consumer spend<strong>in</strong>g.<br />
However considerable attention will also<br />
be paid to the impact of rapid monetary<br />
and fiscal responses. While these<br />
responses will not counter the structural<br />
adjustment currently tak<strong>in</strong>g place <strong>in</strong> the<br />
global economy, it has signalled policy<br />
makers’ will<strong>in</strong>gness to cushion the blow<br />
to the <strong>Australia</strong>n economy. <strong>Australia</strong> was<br />
fortunate to have a strong fiscal position<br />
prior to the onset of the crisis. The second<br />
fiscal package recently announced<br />
shows a will<strong>in</strong>gness to fully exploit this<br />
position and even put the budget <strong>in</strong>to<br />
deficit <strong>in</strong> order to prop up spend<strong>in</strong>g. The<br />
announced package also co<strong>in</strong>cided with<br />
a further 100pb cut to official <strong>in</strong>terest rates,<br />
br<strong>in</strong>g<strong>in</strong>g them to a record low of 3.25%.<br />
These actions mirror the policies of other<br />
G-20 nations <strong>in</strong> a coord<strong>in</strong>ated attempt to<br />
stave off a prolonged global recession.<br />
Comb<strong>in</strong>ed, these actions should moderate<br />
the recent rapid growth <strong>in</strong> non-perform<strong>in</strong>g<br />
loans, however the extent to which they<br />
reaffirm confidence and stabilise the<br />
economy rema<strong>in</strong>s to be seen.<br />
63
Appendix B –<br />
Summary of <strong>Australia</strong>n<br />
Big 4 Banks Basel II disclosures<br />
The follow<strong>in</strong>g provides a summary of the ANZ, CBA, NAB and Westpac’s Basel II disclosures (also known<br />
as Pillar 3 or APS330 disclosures). The figures for ANZ, NAB and Westpac are as of 30 September 2008,<br />
whilst CBA is as of 30 June 2008.<br />
The table below provides a summary of the carry<strong>in</strong>g value of defaulted assets which is def<strong>in</strong>ed as be<strong>in</strong>g 90 days<br />
past due or unlikely to pay.<br />
Exposure<br />
Risk-Weighted<br />
Assets<br />
Exposure<br />
Risk-Weighted<br />
Assets<br />
A$m A$m porportion of porportion of<br />
Non-defaulted assets 2,131,013 655,947 99.5% 95.9%<br />
Defaulted assets - Corporate 6,741 16,891 0.3% 2.5%<br />
Defaulted assets - Consumer/Personal 4,382 11,407 0.2% 1.7%<br />
Total 2,142,136 684,244 100.0% 100.0%<br />
Source PricewaterhouseCoopers<br />
Based on the above the big 4 banks <strong>in</strong> <strong>Australia</strong> are carry<strong>in</strong>g a total of A$6.7 billion <strong>in</strong> corporate loans that<br />
are at least 90 days past due and A$4.3 billion of consumer related loans.<br />
The follow<strong>in</strong>g table provides a summary of the total lend<strong>in</strong>g, defaulted loans, impaired loans and specific provisions<br />
on the balance sheets by <strong>in</strong>dustry for the Big 4. The total write-offs represent loans written off to the profit and loss<br />
for the respective year ends collectively for the big 4 banks. These write-offs are typically taken as either a charge<br />
to the specific provisions or a charge to the collective provisions for credit losses. The big 4 banks have written<br />
off a total of A$1.4 billion <strong>in</strong> consumer and A$1.0 billion <strong>in</strong> corporate loans for the 12 month period.<br />
As can be seen <strong>in</strong> the table below Specific Provisions are considerably lower than the value of Impaired Loans. In many<br />
cases a bank may not be able to accurately estimate the Individual/Specific Provision, <strong>in</strong> which case it will estimate the<br />
credit risk provision on a collective basis. The collective provisions for the Big 4 banks were approximately A$8.0 billion.<br />
By far the largest exposure for defaulted loans is the Personal sector, which <strong>in</strong>cludes a considerable volume<br />
of residential mortgages. On the Corporate side the largest exposure is <strong>in</strong> the property and bus<strong>in</strong>ess services<br />
sector with total of A$2.1 billion <strong>in</strong> defaulted loans.<br />
64
Industry<br />
Exposure<br />
Defaulted<br />
Loans<br />
Impaired<br />
Provisions<br />
Specific<br />
Write-Offs<br />
A$m A$m A$m A$m A$m<br />
Accommodation, cafes, pubs and restaurants 24,975 177 120 33 16<br />
Agriculture, forestry, fish<strong>in</strong>g and m<strong>in</strong><strong>in</strong>g 111,223 434 320 91 46<br />
Construction 30,996 453 365 83 40<br />
F<strong>in</strong>ance and surance 377,898 1,100 939 290 209<br />
Manufactur<strong>in</strong>g 98,263 666 608 305 150<br />
Personal * 983,996 4,382 1,411 614 1,442<br />
Property and bus<strong>in</strong>ess services 230,363 2,113 1,659 249 192<br />
Trade 93,771 815 488 211 196<br />
Transport and storage 46,146 145 112 46 37<br />
Energy 17,611 2 0 0 -6<br />
Sovereign 22,897 0 0 0 0<br />
Other 103,997 836 600 300 103<br />
Total 2,142,136 11,123 6,682 2,222 2,425<br />
Source PricewaterhouseCoopers<br />
65
Useful websites<br />
BLAKE DAWSON<br />
www.blakedawson.com<br />
The Blake Dawson website <strong>in</strong>cludes <strong>in</strong>formation about the firm, updates on recent legal developments,<br />
partner profiles and contact details.<br />
PRICEWATERHOUSECOOPERS<br />
www.pwc.com/au/car<br />
<strong>PwC</strong>’s Corporate Advisory & Restructur<strong>in</strong>g division is a dedicated team of specialists with extensive<br />
skills <strong>in</strong> diagnos<strong>in</strong>g, advis<strong>in</strong>g on and deploy<strong>in</strong>g commercial solutions for underperform<strong>in</strong>g, <strong>in</strong>efficient<br />
or distressed organisations and those confronted with unexpected events.<br />
ASIA-PACIFIC LOAN MARKET ASSOCIATION<br />
www.aplma.com<br />
The Asia-Pacific Loan Market Association is the trade association for the syndicated loan trad<strong>in</strong>g<br />
market <strong>in</strong> the region.<br />
AUSTRADE<br />
www.austrade.gov.au<br />
The <strong>Australia</strong>n Trade Commission (Austrade) is the <strong>Australia</strong>n Government’s trade and <strong>in</strong>vestment<br />
development agency.<br />
AUSTRALIAN BUREAU OF STATISTICS (ABS)<br />
www.abs.gov.au<br />
The ABS website provides statistics for a wide range of economic and social <strong>in</strong>dicators.<br />
AUSTRALIAN LEGAL MATERIALS (LEGISLATION AND CASE LAW)<br />
www.law.gov.au<br />
An onl<strong>in</strong>e resource provid<strong>in</strong>g <strong>in</strong>formation about the <strong>Australia</strong>n legal system and relevant<br />
government organisations.<br />
www.austlii.edu.au<br />
This website provides access to <strong>Australia</strong>n legal materials.<br />
AUSTRALIAN SECURITIES EXCHANGE (ASX)<br />
www.asx.com.au<br />
ASX operates <strong>Australia</strong>’s primary national stock exchange.<br />
CORPORATE REGULATION<br />
www.asic.gov.au<br />
The <strong>Australia</strong>n Securities and Investments Commission regulates <strong>Australia</strong>’s companies.<br />
66
DEBTWIRE<br />
www.debtwire.com<br />
Debtwire is a commercial <strong>in</strong>formation provider to the fixed <strong>in</strong>come markets. It publishes regional surveys<br />
of distressed debt markets.<br />
FOREIGN INVESTMENT<br />
www.firb.gov.au<br />
The Foreign Investment Review Board exam<strong>in</strong>es proposals by foreign <strong>in</strong>terests to undertake direct<br />
<strong>in</strong>vestment <strong>in</strong> <strong>Australia</strong>.<br />
GOVERNMENT INFORMATION<br />
www.gov.au<br />
The Government Entry Po<strong>in</strong>t provides access to <strong>Australia</strong>n Federal, State, Territory and Local<br />
Government websites.<br />
www.bus<strong>in</strong>ess.gov.au<br />
The Bus<strong>in</strong>ess Entry Po<strong>in</strong>t is a government resource for bus<strong>in</strong>ess.<br />
INSOLVENCY PRACTITIONERS ASSOCIATION OF AUSTRALIA<br />
www.ipaa.com.au<br />
The trade association for <strong>Australia</strong>n <strong>in</strong>solvency professionals.<br />
LOAN MARKETING ASSOCIATION<br />
www.lma.eu.com<br />
The European trade association for the syndicated loan trad<strong>in</strong>g market.<br />
LOAN SYNDICATION AND TRADING ASSOCIATION<br />
www.lsta.org<br />
The Loan Syndications and Trad<strong>in</strong>g Association is the US association for the syndicated loan trad<strong>in</strong>g market.<br />
PROPERTY<br />
www.propertyoz.com.au<br />
The Property Council of <strong>Australia</strong> is the peak <strong>in</strong>dustry body for the <strong>Australia</strong>n commercial real estate sector.<br />
TAXATION<br />
www.ato.gov.au<br />
The <strong>Australia</strong>n Taxation Office’s website <strong>in</strong>cludes <strong>in</strong>formation for bus<strong>in</strong>ess, large corporates and mult<strong>in</strong>ationals.<br />
TMA<br />
www.turnaround.org.au<br />
The Turnaround Management Association is the only <strong>in</strong>ternational non-profit association dedicated<br />
to corporate renewal and turnaround management.<br />
67
Contribut<strong>in</strong>g authors<br />
Blake Dawson<br />
Michael Sloan<br />
Partner, Restructur<strong>in</strong>g & Insolvency<br />
Duncan Baxter<br />
Partner, Tax<br />
Carl Della-Bosca<br />
Partner, Corporate<br />
Jemaya Barlow<br />
Senior Associate, Restructur<strong>in</strong>g & Insolvency<br />
James Marshall<br />
Partner, Restructur<strong>in</strong>g & Insolvency<br />
Matthew May<br />
Partner, Restructur<strong>in</strong>g & Insolvency<br />
Stephen Menzies<br />
Partner, Corporate<br />
Paul O’Donnell<br />
Partner, Tax<br />
Paul Pyanic<br />
Senior Associate, Tax<br />
David Ryan<br />
Partner, Corporate<br />
Marcus Ryan<br />
Senior Associate, Tax<br />
Steve Smith<br />
Partner, Bank<strong>in</strong>g & F<strong>in</strong>ance<br />
Natasha McHattan<br />
Senior Associate, Restructur<strong>in</strong>g & Insolvency<br />
Sanjay Wavde<br />
Senior Associate, Tax<br />
68
PricewaterhouseCoopers<br />
Michael Codl<strong>in</strong>g<br />
Partner, F<strong>in</strong>ancial Assurance<br />
Nick Colman<br />
Manager, <strong>Distressed</strong> Debt Group<br />
Melissa Humman<br />
Director, Corporate Advisory and<br />
Restructur<strong>in</strong>g<br />
Frank Janik<br />
Director, <strong>Distressed</strong> Debt Group<br />
Paul Kirk<br />
Partner, Corporate Advisory and Restructur<strong>in</strong>g<br />
Scott Lennon<br />
Partner, Economics and Strategy<br />
Steven Lim<br />
Partner, Actuarial Services<br />
Michael McCreadie<br />
Partner, <strong>Distressed</strong> Debt Group<br />
Rob Spr<strong>in</strong>g<br />
Partner, F<strong>in</strong>ancial Assurance<br />
Tom Toryanik<br />
Senior Manager, Tax and Legal Services<br />
Rob Tyson<br />
Manager, Economics and Strategy<br />
69
Contact <strong>in</strong>formation<br />
For further <strong>in</strong>formation, please contact:<br />
Blake Dawson<br />
James Marshall<br />
Partner, Sydney<br />
Restructur<strong>in</strong>g & Insolvency<br />
T 61 2 9258 6508<br />
james.marshall@blakedawson.com<br />
PricewaterhouseCoopers<br />
Michael McCreadie<br />
Partner, Melbourne<br />
<strong>Distressed</strong> Debt Group<br />
T 61 3 8603 3083<br />
michael.mccreadie@au.pwc.com<br />
www.blakedawson.com<br />
www.pwc.com.au