Korea’s Corporate Restructuring since the Financial Crisis:Measures and Assessment

Chan-Hyun Sohn

Senior Fellow

Korean Institute for International Economic Policy

CONTENTS

I. Introduction

II. Evolution of the Financial Crisis

and the Korean Government’s Initiatives

III. First Stage of Corporate Restructuring - A stage of government-led reform

IV. Second Stage of Corporate Restructuring - A trial towards a market-based system

V. Assessment

VI. Conclusion

GDP & GDP growth rate

0

100

200

300

400

500

600

1994 1995 1996 1997 1998 1999 2000 2001 2002

-8-6-4-2024681012

GDP economic growth rate

1

Trends of macroeconomic indicators

2

0

2

4

6

8

10

12

14

16

1995 1996 1997 1998 1999 2000 2001

Year

%

0

200

400

600

800

1000

1200

1400

1600

1800

Won

/$

Unemployment rate Interest rate Foreign exchange rate

Trends of credit rating: Korea

Company Pre-crisis During the crisis Post-crisis

Fitch IBCA AA- B- (-12) BBB+ (+8)S&P AA- B+ (-10) BBB+ (+7)Moody's A1 Ba1 (-16) Baa2 (+12)

Source: Ministry of Finance and Economy (2001).

3

Reasons for Korea’s Financial Crisis

▣ Currency illiquidity

▣ Chronic structural problems during the high growth period

The excessive investment and diversification of Korean corporations

through debt financing

- backed by government-administered credit allocation

- through irrational corporate governance

4

Profitability and opportunity cost of capital for Korean manufacturing firms

-10

-5

0

5

10

15

20

25

30

35

67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97

net profit/net worth financial expenses to total borrowing

5

The Principles of Corporate Restructuring

▣ Five tasks - to enhance the transparency of

management

- to eliminate mutual debt guarantees

- to improve the financial structure ofcorporations

- to focus the conglomerates on coreactivities

- to strengthen the responsibility ofcontrolling shareholders andmanagement

▣ Three accompanying principles

- Financial institutions that provide loanto corporations were to take a leading rolein promoting corporate restructuring.

- The principle of burden-sharing was tobe applied in the process of corporaterestructuring.

- The workout program was to be usedas the main tool for corporaterestructuring.

6

Financial Reform Measures Related to Corporate Restructuring

▣ The shut-down of no longer viable financial institutions (including banks), dueto excessive non-performing loans (NPLs)

▣ The recapitalization of the First Bank of Korea and Seoul Bank

▣ The inspection by accounting firms on 12 banks that had failed to meet theBIS capital adequacy ratio

▣ The strengthening of provision requirements and loan classification standardsbased on forward-looking criteria

▣ The overhauling of non-bank financial institutions (NBFIs), on which firmsdepended on for debt financing before the crisis

7

9

Out-of-Court Debt Workout

▣ London Approach

▣ Principle

- Burden-sharing with financial institutions

▣ Agreement & institutions

- Corporate Restructuring Accord (CRA)

- Corporate Restructuring Co-ordination Committee (CRCC)

- Korean Asset Management Company (KAMCO)

▣ Tools for adjusting debts

- Capital Structure Improvement Plans (CSIPs) - debt/equity swaps, term extensions, deferred payment of principal or interest,

interest rate cuts, and provision of new credits

8

Three Different Approaches

Criteria : The firm’s restructuring capacity

1) The top five chaebols with the capacity to absorb the resulting losses:

pursued ‘self-directed restructuring’

2) The Daewoo Group and the 6th to 64th largest conglomerates

with the inability to restructure successfully on their own:

entered into “workouts” with financial institutions

3) The SMEs too weak to bear the costs of restructuring:

supported by their creditor financial institutions

10

Improvement of financial structureImplementation of restructuring plans of the top four chaebols

End-1998 June, 1999 Implemen tation(A) (B) End- 1999 Chan Ges

Plans(C)

Achievement(D)

(D-A) (D-B)

Debt/equity ratio 352 254.6 197.7 173.9 178.1 180.7Debt 165.1 160.9 128.3 139.6 25.5 21.3Equity 46.9 63.2 64.9 80.3 33.4 17.1 Source: FSC (quoted from Shin. et al. (2000)).

P l a n A c c o m p l i s h m e n t I m p l e m e n t a t i o n r a t e1998 ( A ) 1 9 9 9 ( B ) ( B / A , % )

S e l f - r e s t r u c t u r i n ge f f o r t (Tr i l l ion w o n )

3 3 3 7 . 7 114 .4

A s s e t s a l e s 1 3 . 7 1 5 109 .6R a i s i n g c a p i t a l 1 9 . 3 2 2 . 7 117 .8I n d u c e m e n t o ff o r e i g n c a p i t a l( B i l l i o n w o n )

7 1 . 9 8 4 . 3 117 .2

P r o h i b i t i o n o f C r o s sd e b t g u a r a n t e e( T r i l l i on won)

2 .7 3 .1 116 .7

S p i n - o f f s 173 442 255 .5I m p r o v e m e n t o fc o r p o r a t e g o v e r n a n c e

136 143 105 .1

R e d u c t i o n o fa f f i l i a t e s

8 4 9 4 111 .9

S o u r c e : F S C ( q u o t e d f r o m S h i n . e t a l . ( 2 0 0 0 ) ) . 12

Big Deals

Indus t ry P l a n Control l ing bodySemiconductors

Power-generatingequipment

Petrochemicals

Aircraftmanufacturing

Rai l roadvehicles

Ship engines

Oil refining

C a r s1

Samsung Electronic Co. àHyundai Electronics Ind. Combine àLG Semiconductor Co.

Hyundai Heavy Industr ies Co.Korea Heavy Industr ies & Construct ion Co. Combine àSamsung Heavy Industr ies Co.

SK,LG, Dael im, Lot te , Hanwha àHyundai Petro-chemical Co. Combine àSamsung Genera l Chemica l Co.

Samsung Aerospace Indus t r ies Co.Daewoo Heavy Indus t r ies Co. Combine àHyundai Space & Airc ra f t Co .

Hyundai Prec is ion & Ind. Co.Daewoo Heavy Indus t r ies Co. Combine àHanjin Heavy Industr ies Co.

Hyundai Heavy Industr ies Co. àKorea Heavy Industr ies & Construct ion Co. Combine àSamsung Heavy Industr ies Co.

SK, LG, Ssangyong àHyudai Oi l Co. Combine àHanwha Energy Co .

Hyunda i Moto r s2 àDaewoo Motors

3 Combine à

Samsung Motors

Samsung Electronics Co.Hyundai Electronics Ind.(Agreement reached in January 1999)

Korea Heavy Industr ies& Construct ion Co.

SK, LG, Dael im, Lot te , HanwhaNew ent i ty

New ent i ty

Third-party professional manager

Hyundai Heavy Industr ies Co.Korea Heavy Industr ies& Construct ion Co.

Sk, LG, SsangyoungHyundai Oi l Co.

Hyunda i Moto r s2

Daewoo Motors

1 . Added in December 1998.2 . Hyundai Motors acquired Kia Motors ear l ier in 1997.3 . Daewoo Motors acquired Ssangyong Motors in 1997.Source: Yoo (quoted f rom OECD (1999)) .

11

Selection of firms under the workout program and their progressWorkout plans and implementation (hundred million won, %)

N o m i n a t e d E x c l u d e d P r e S e n t( A ) T o t a l ( B ) D r o p p e d o u t M e r g e d E j e c t e d G r a d u a t e d

( C )R e m a i n i n g

( A - B - C )D a e w o o

C o m p a n i e s1 2 1 0 0 1 1 1 0

A f f i l i a t e s o f6 - 6 4 C o n -g l o m e r a t e s

4 9 2 2 5 1 2 5 1 2 1 5

M e d i u m -s i z e d f i r m s

4 3 1 1 3 3 5 2 3 9

T o t a l 1 0 4 3 4 8 1 5 1 1 3 6 3 4

S o u r c e : O E C D ( 2 0 0 1 ) .

Classification Debt Adjustment New

Deferred Payment Debt/equityswaps

Others Total Credits

Interest ratecut

Normalinterest rate

Non-Daewoo Plan 189,277 47,950 72,401 10,347 319,975 10,982

56 Achievement 171,696 34,627 28,572 37,591 272,486 11 ,313Implementat ion rat io(%) 90.7 72.2 39.5 363.3 85.2 103

Daewoo Plan 533,641 11,888 85,849 34,389 665,767 56 ,110

12 Achievement 530,744 11,888 5,666 35,257 583,555 37,209Implementat ion rat io(%) 99.5 100 6.6 102.5 87.7 66.3

Total Plan 722,918 59,838 158,250 44,736 985,742 67,092

68 Achievement 702,440 46,515 34,238 72,848 856,742 48,522Implementat ion rat io(%) 97.2 77.7 21.6 162.8 86.8 72.3

Source: FSC (quoted from Shin. et al . (2000)). 13

Small and Medium-Sized Enterprises (SMEs)

▣ At the initial stage, before 2000

· Government’s direction to banks to roll over loans to SMEs

· Government’s provision of W33 trillion of guarantees for loans to small firmsand additional budgetary support of W2.2 trillion through a variety ofprograms

· Twenty-five financial institutions’ establishment of the CorporateRestructuring Fund and raising W1.6 trillion to assist small companies

· The central bank’s change in its criteria for setting credit ceilings

· Tax benefits

▣ From 2000

· Partial guarantees14

Development of Restructuring Intermediates

• Korean Asset Management Corporation (KAMCO)

• Corporate Restructuring Fund (CRF)

• Corporate Restructuring Company (CRC)

• Corporate Restructuring Vehicle (CRV)

15

16

Registration of CRF

Classification Form Scale (hundred million) Management companySeoul Debt Debt fund 6,000 Rothschild Inc.

Arirang Mutual fund 3,334 State Street Bank & Trust Co.Mugoongwha Mutual fund 3,333 Scudder Kemper Investments Inc.

Hangang Mutual fund 3,333 Templetion Asset ManagementLtd.

Source: FSC (quoted from KERI (2001).

17

18

Registration of CRC and Vulture Fund

RegistrationYear

Paid-in capital1)

Listing or unlisting Shareholder InvestorClassification

‘ 99 ‘ 00 Morethan 5Bil.

Lessthan5 Bil

Exchange

KOSDAQ

Unlisting

Corp. Private

Native

Foreigner

No. 20 22 8 34 1 1 40 31 11 37 51) Total paid-in capital: W 500.9 billionSource: Lee, C. (2000).

Fund name Registration date Fund operator Totalinvestment

First Comet M&A fund ’99.9.9 Comet Investment Corp. W 23.8 BilFirst KTIC fund ’99.10.8 Korea Technology Investment Corp. W 208 BilFirst KTB fund ’99.12.9 KTB Network Co., Ltd. W 13.5 BilFirst QCP fund ’00.1.25 Q Capital W 1.5 BilSecond KTB fund ’00.3.3 KTB Network Co., Ltd. W 55 BilThird KTB fund ’00.4.10 KTB Network Co., Ltd. W 50 BilSource: Lee, C. (2000).

19

Investment accomplishment (Unit: W Billion)

Classification Underwriting Purchase of assets &bonds

Total

Amount ofmoney

167 135.8 302.81999. 6-12

Number of cases 49 cases 14 cases 63 casesAmount of

money60.2 627.8 688.82000. 1-5

Number of cases 3 cases 62 cases 65 casesAmount of

money227.2 763.6 991.6Total

Number of cases 52 cases 76 cases 128 casesSource: Lee, C. (2000).

20

Corporate Restructuring Vehicle (CRV)

▣ Corporate Restructuring Vehicle Act with six years validity fromOctober 2000

▣ A type of a paper company that is a mutual fund for a limited periodof time

▣ For the purpose of the complementing of weaknesses of CRC andCRF and the facilitation of corporate restructuring

▣ Management & function

21

Elimination of Regulations on M&A

The full liberalization of all forms of M&As by 1998

▣ The liberalization of hostile M&As as well as friendly M&As

▣ The allowance of foreign direct investment (FDI) in Korean enterprises:

the opening-up of several industries to FDI - construction, leasing, securities,

and futures brokerage

▣ The abolishment of the ceiling on total foreign shareholdings

in individual companies

▣ The revoking of the rule that limited holdings acquired without the approval of

the board of directors to only 10%

▣ The abolishment of two important stock market rules

1) the rule requiring statutory tender offers in the case of a purchase of 25% or more

2) the disclosure of incremental acquisitions of stakes larger than 5%

22

Corporate Governance

1. Enhancement of Transparency of Corporate Management

- Improvement of the Corporate Account Auditing Procedure

- Introduction of Combined Financial Statements

- Improvement of Corporate Public Disclosure

2. Strengthening Minority Shareholder Rights

3. Strengthening the Responsibility of Controlling Shareholders andManagement

4. Prohibition of Inappropriate Intra-Group Transactions and DebtGuarantees

- Inappropriate Intra-Group Transactions

- Abolishing Mutual Debt Guarantees

23

The rate of intra-group transactions among the top thirty groups

Group ‘86 ‘87 ‘88 ‘89 ‘96 ‘97Top 5th 28.25 25.52 27.71 29.62 29.80 35.77Top 10th 26.27 24.36 25.55 26.37 29.16 32.77Top 20th 24.17 22.61 24.14 24.42 27.14 29.85Top 30th 23.14 21.98 23.39 23.73 26.94 27.74

Source: KERI (2000).

24

Trends of Debt Guarantees of the Top 30 GroupsFinancial Structure of Insolvent Companies

Debt Guarantee Net Worth to Total Assets Date Equity(A)

Total(B)Restricted

Companies(C)Excluded

Companies(D)B/A C/A

1993.4.1 35.2 165.5 120.6 44.9 469.8 342.41994.4.1 42.8 110.7 72.5 38.2 258.1 169.31995.4.1 50.7 82.1 48.3 33.8 161.9 95.21996.4.1 62.9 67.5 35.2 32.3 107.3 55.91997.4.1 70.4 64.9 33.6 31.3 92.2 47.71998.4.1 68.1 63.5 26.9 36.6 93.1 39.51999.4.1 100.1 22.4 9.8 12.6 22.3 9.7

Source: FTC (2000).

Hanbo Sammi Jinro Kia 30 LargestDebt Ratio(End of 1996) 675 3,244 3,746 517 387Debt Guarantee Ratio(April 1997)

309.4 740.7 473.3 110.8 91.3

Dependency on Loans 57.7 62.7 78.2 51.3 48.4Financial cost rate 5.8 14.5 21.4 7.0 4.9Increase Rate ofAffiliates(Past 3 Years)

262.5 - 200 200 31.5

Net Income (in KRW billion) -46 -125 -138.1 -125.1 12.3 Source: FTC (2000). 25

System for Corporate Restructuring on a Regular Basis

▣ Corporate Restructuring Promotion Law (effective until 2005) and itsEnforcement Ordinance

▣ Motivation:

:Problems emerged during two periods of purge of troubled companies

▣ Strengthened supervision on insolvent firms

- Day-to-day credit checking system

- Criteria for a bad credit company

1) under-performs on the ratio of sales profits to financial costs

for three consecutive years

2) categorized in the precautionary level based on the FLC system

3) already being monitored as a potential insolvent company.

26

27

Corporate Restructuring Real Estate Investment Trusts(CR-REITs)

▣ Real Estate Investment Trust Law (in April 2001)

▣ Corporate Restructuring Real Estate Investment Trusts (CR-REITs) (inMay)

- for the facilitation of corporate restructuring through investments

in the real estate of restructuring companies

▣ A kind of paper company

▣ Management and function

28

Indicators of financial stability and dependence on borrowed funds(%)Trends in the structure of corporate finance (Unite: trillion won)

90~96average 97 98 99 00 U.S. (1sthalf of 01)

Japan(99)

Debt-equity ratio 1) 301.7 396.3 303 214.7 210.6 154.4 174

Total borrowingsand bonds payableto total assets 2)

45.7 54.2 50.8 42.8 41.2 27.7 33.1

Current ratio 3) 94.8 91.8 89.8 92 83.2 124.4 134

Note: 1) debts / assets, 2) (borrowings + bonds) / total assets, 3) current asset/total liabilities. Source: Bank of Korea (2001).

1 9 9 7 1 9 9 8 1 9 9 9

Indirect financing 43.4 -15.9 2.1Deposi t money banks 15.2 0.7 15.1Nonbanks 28.2 -16.6 -13

Direct f inancing 44.1 49.5 26.8Stocks 11.6 14.7 41.6Bonds 28 46.5 1.7CP 4.4 -11.7 -16.5Overseas f inancing 6.6 -9.8 10Tota l 94 23.8 38.9 Source: Bank of Korea (quoted from the Richards. et al . (2001)). 29

Trends of main indicators related to profitability in themanufacturing industry (%)

Interest coverage ratio (Unit: Component ratio, %)

90~96average

97 98 99 00 U.S.(1st half of 01)

Japan(99)

Operating income tosales 1)

7.6 7.5 8.8 7.8 8.6 5.4 2.9

Ordinary income tosales 2)

2.6 1.4 -0.4 4.2 5.1 2.8 2.9

Note: 1) Operating income is the difference between the revenue of a business and its related costs andexpenses, excluding income derived from source outside its regular activities.

2) Ordinary income is operating income after losses or gains from interest expenses, income, foreigncurrency transactions, and disposals of investment and tangible assets.

Source: Bank of Korea (2001).

Interest Coverage Ratio Less than0%

0-50% 50-100% 100-150%

150-200%

More than200%

Number ofCompany

First Half of ’00First Half of ‘01

12.314.0

6.771

7.78.9

10.710.3

8.97.7

50.549.1

Loans First Half of ’00First Half of ‘01

14.820.7

16.714.0

13.315.3

19.510.0

11.613.3

24.026.7

Source: Bank of Korea (2001).

30

Turnover and productivity (%)

1996 1997 1998 1999 2000

Asset turnover ratio 1) 96.8 87.3 88.7 86.8 100.5 Chaebols 117.6 104.5 108.9 108.4 128.6 Non-chaebols 66 60.3 57.6 54.1 60.2

Operating profit per employee(1000 won)

17,043 24,790 22,353 28,551 38,147

Sales per employee (1000 won) 310,929 388,682 493423 536,644 597,247Net income per employee (1000 won) 1,698 -2,853 -21289 1,734 -8,764Number of employees 799,683 732,114 732114 618,855 622,044

Note: 1) sales / assets Source: IMF (2002).

31

Was the government’s policy a real process of corporaterestructuring based on a market economy principle?

▣ “Bankruptcy suspension”

▣ The negligent attitudes of the government and banks

- the government’s delayed reform and excessive support forinsolvent banks and firms

- no exit of insolvent firms by creditor banks, under the government’scontrol, for fear of aggravating their financial structure

32

Unfinished agenda

▣ The continuation of substantial restructuring of the chaebols

▣ The development of market-driven mechanisms for corporate

restructuring

▣ The guarantee of the autonomy of financial institutions

33