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1 Corporate Adjustment and Restructuring in Thailand by Dr. Yunyong Thaicharoen Prapan Kiatikomol 2 Contents 1. Introduction 2. Corporate Adjustment and Performance - Role of Monetary Policy 3. Links between Firm Balance Sheet Condition and Investment: Panel Regression Analysis 4. Conclusions and Policy Recommendations 3 I. Introduction Weakness in Corporate sector played a central role in the Balance Sheet Crisis (e.g. Paul Krugman (1999)) Lack of Credit Flows Weak FIs FIDF Baht Depreciation NPL Leveraged corporate sector High public debt Deteriorated confidence Low Tax Revenue Investment Collapse Output Crisis 4 Cross country evidence shows link between initial high leverage ratio and subsequent output loss 5 Real GDP growth, deviation from trend, Taiwan Philippines - Singapore - Hong Kong - Korea Malaysia Thailand - Indonesia . . . . . Corporate Debt/Equity Ratio, Source: Strong (2000), Claessens et al. (1998) . . While GDP has returned to the pre-crisis level in 2002, …. * Real GDP for Crisis-Hit Countries 130 120 1997q2 = 100 Index 110 100 90 80 70 Thailand Indonesia Malaysia Korea Philippines 60 Q1: 93 Q1: 94 Q1: 95 Q1: 96 Q1: 97 Q1: 98 Q1: 99 Q1: 00 Q1: 01 Q1: 02 Source: CEIC * Real GDP (Seasonally adjusted) 6 7 Investment recovery has been slow, reaching only 57 percent of the pre-crisis level, and lagging behind other countries. Index Investment Level for Crisis-Hit Countries 130 120 110 100 90 80 70 60 50 40 Q1: 93 1997q2 = 100 Q1: 94 Q1: 95 Q1: 96 Thailand Indonesia Philippines Malaysia Korea Q1: 97 Q1: 98 Source: CEIC * Real Investment (Seasonally adjusted) Q1: 99 Q1: 00 Q1: 01 Q1: 02 8 II. Corporate Sector Development 9 Data Issues Source: ISIMS database form SET Period: Quarterly data from 1994-2001 Type of data: Firm level data - 371 Non-financial Public listed Companies - Balance Sheet and Income Statement 10 Financial Ratios Debt to Equity Ratio = Total Liabilities / Shareholders’ Equity Return on Average Assets (ROAA) = (Net Income / Average Total Assets) *100 Average Asset Turnover = (Sales / Average Total Assets)*100 Net Profit Margin = (Net Income / Sales) *100 Quick Ratio = (Current Assets – Inventories) / Current Liabilities Interest Coverage Ratio (ICR) = Earning before Interest and Tax (EBIT) / Interest Expense Pre-crisis: During 1993-1996, GDP grew around 8 percent per annum, driven by high investment financed mostly by bank debt. Private Investment* Private Credit Growth Growth (LHS) 30 25 10 5 0 1993 1994 1995 1996 % of GDP (RHS) 12 10 8 6 4 2 0 33 32 31 1993 1994 Source: NESDB Source: Bank of Thailand 34 1995 1996 30 * At 1988 price External Debt* 60 External borrowing induced by: - Domestic Interest Rate > Foreign’ s - Fixed Exchange Rate 40 20 0 1993 1994 1995 Source: Bank of Thailand * Private (non-bank) 1996 % 15 % % 20 Bn US$. 11 12 Led to … Liabilities and Equity 3000 Equity 2500 2000 Bn Bt • Lt lia Cur lia • 1500 1000 Total Asset rose quickly High ratio of current liabilities to Total liabilities Liabilities grew faster than Equity 500 0 1993 1994 1995 1996 Debt to Equity Ratio 2 X 1.5 1 D/E rose to almost 2 in 1996 0.5 0 1993 1994 Source: SET data and authors estimate 1995 1996 Liquidity and profitability had deteriorated well before the crisis, leaving firms’ balance sheet position in vulnerable conditions. Return on Average Assets (ROAA) Average Assets Turnover 20 1.4 Mean 1.2 18 0.8 % % 1 0.6 0.4 Mean 0.2 Median Median 16 14 0 12 94q1 94q3 95q1 95q3 96q1 96q3 94q1 94q3 95q1 95q3 Quick and Interest Coverage Raitos 7 X 0.9 ICR (RHS) 6 Quick (LHS) 5 0.8 4 3 0.7 2 0.6 1 94q1 Source: SET data and authors estimate 94q3 95q1 95q3 96q1 96q3 X 1 96q1 96q3 13 14 The Effect on the Corporate Sector 1. Balance Sheet Effect 2. Collapse of Domestic Demand Rising Debts Increasing Interest Expense Closing Down Restructuring Contraction of Sales and Profit Lower Equity 15 Crisis and beyond: Debt to Equity Ratio increased considerably in 1997. Since then it fell slowly, and speeded up in 2001. Debt to Equity Ratio 6 49 5 Bt/US$ 4 Median 44 39 3 34 2 1 29 0 24 94q1 95q1 96q1 Source: SET data and authors estimate 97q1 98q1 99q1 00q1 01q1 02q1 Bt/US$ X Mean 16 The corporate sector has been continuously reducing its debt burden and shifting to more long term maturity debt. Liabilities and Equity Bn Bt 3500 Equity 3000 Lt lia 2500 Cur lia 2000 1500 1000 500 0 1993 1994 Source: SET data and authors estimate 1995 1996 1997 1998 1999 2000 2001 17 Liquidity was worsened during the crisis… Quick Ratio Quick Ratio declined rising current liabilities, 1 X 0.8 but has now improved thank to 0.6 • • Mean 0.4 Median winding down liabilities gradual recovery of demand. 0.2 94q1 95q1 96q1 97q1 98q1 99q1 00q1 01q1 02q1 Interest Coverage Ratio (ICR) • 7 6 Mean 5 X 4 • Increased costs esp. interest expense Falling domestic demand, Median 3 2 1 0 -1 94q1 ICR fell because of 95q1 96q1 97q1 98q1 -2 Source: SET data and authors estimate 99q1 00q1 01q1 02q1 but has been improving, though still susceptible to economic uncertainty. 18 Profitability reached the lowest in 97q4 due to… Return on Average Assets (ROAA) Average Assets Turnover 10 22 Mean 20 5 Median 18 % 94q1 -5 -10 95q1 96q1 97q1 98q1 99q1 00q1 01q1 02q1 % 0 Mean 14 Median 12 10 -15 94q1 Net Profit Margin • 60 40 20 0 % 16 -20 94q1 -40 -60 -80 95q1 96q1 97q1 98q1 99q1 00q1 01q1 -100 -120 Source: SET data and authors estimate 96q1 97q1 98q1 99q1 00q1 01q1 • High interest expense and depreciation Weak domestic demand • • ROAA improved thereafter owing to better economic condition, but still volatile & vulnerable. 02q1 Mean Median 95q1 02q1 Debt to Equity Ratio: Mode was around 1.2 in 1995, then… Debt to Equity Ratio 0.12 0.1 Density 0.08 1995 0.06 0.04 0.02 0 -22 -19 -17 -15 -13 -11 -9 -6 -4 -2 0 2 4 7 D/E (X) Source: SET data and authors estimate 9 11 13 15 17 20 22 24 26 28 30 19 20 …rose to 2.3 in 1997, while more distribution shifted to more extreme values. (fat tails) Debt to Equity Ratio 0.12 0.1 1997 Density 0.08 1995 0.06 0.04 0.02 0 -22 -19 -17 -15 -13 -11 -9 -6 -4 -2 0 2 4 7 D/E (X) Source: SET data and authors estimate 9 11 13 15 17 20 22 24 26 28 30 Subsequently, in 2001, the mode declined to 1995’s level, but still had fatter tails. Debt to Equity Ratio 0.12 0.1 2001 Density 0.08 1997 1995 0.06 0.04 0.02 0 -22 -19 -17 -15 -13 -11 -9 -6 -4 -2 0 2 4 7 D/E (X) Source: SET data and authors estimate 9 11 13 15 17 20 22 24 26 28 30 21 ROAA was quite low before the crisis then deteriorated dramatically in 1997. It improved gradually along with the economy , but is still fragile. Return of Average Assets (ROAA) 0.07 0.06 1995 Density 0.05 0.04 0.03 0.02 0.01 0 -91 -83 -75 -66 -58 -50 -41 -33 -25 -16 ROAA (% ) Source: SET data and authors estimate -8 0 9 17 25 34 42 22 ROAA was quite low before the crisis then deteriorated dramatically in 1997. It improved gradually along with the economy , but is still fragile. Return of Average Assets (ROAA) Density 0.07 0.06 1997 0.05 1995 0.04 0.03 0.02 0.01 0 -91 -83 -75 -66 -58 -50 -41 -33 -25 -16 ROAA (% ) Source: SET data and authors estimate -8 0 9 17 25 34 42 23 ROAA was quite low before the crisis then deteriorated dramatically in 1997. It improved gradually along with the economy , but is still fragile. Return of Average Assets (ROAA) 0.07 2001 0.06 1997 Density 0.05 1995 0.04 0.03 0.02 0.01 0 -91 -83 -75 -66 -58 -50 -41 -33 -25 -16 ROAA (% ) Source: SET data and authors estimate -8 0 9 17 25 34 42 24 ICR deteriorated in 1997, then improved thereafter. However, as of 2001, many firms remain relatively illiquid, even compared with 1995’s. Density Interest Coverage Ratio (ICR) 0.1 0.09 0.08 0.07 0.06 0.05 0.04 0.03 0.02 0.01 0 2001 1997 1995 -15 -12 -8 -5 -1 2 6 9 12 16 ICR (X) Source: SET data and authors estimate 19 23 26 30 33 37 40 25 26 Uneven effects of the crisis and subsequent recovery across sectors…. Debt to Equity Ratio Return on Average Assets 12 10 Trade 10 Ntrd 8 0 -5 6 1994 1995 1996 1997 1998 1999 2000 2001 % X 5 4 -10 Trade 2 -15 Ntrd 0 -20 1994 1995 1996 1997 1998 1999 2000 2001 -25 Interest Coverage Ratio 4.0 3.5 • Non-Tradable was more adversely affected by the crisis. • Tradable Sector recovered more quickly than Non-Tradable. 3.0 X 2.5 2.0 1.5 Trade 1.0 Ntrd 0.5 0.0 -0.5 1994 1995 1996 1997 1998 Source: SET data and authors estimate 1999 2000 2001 Though improving, many Thai firms remain vulnerable to financial distress by Industry’s standard measure. Ratios Weight ROA 3.3 Sales / Assets 0.999 Equity / Debt 0.6 Working Cap / Assets 1.2 Retained Earning 1.4 Z > 2.99 1.8 < Z < 2.99 Z < 1.8 Safe Zone Gray Zone Distress Zone Altman's Z-Score 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 2536 Source: SET data and authors estimate 2538 zsc_median_all 2540 2542 2544 zsc_median_no_rehab&delisted 27 28 Role of Monetary Policy: Sensitivity Analysis Objective: Study the effect of Monetary Policy on the firm’s balance sheet Methodology: Sensitivity Analysis of 1st round effect of a reduction in the policy rate by 1 percent. Main Assumption Deposit Rate RP 14 day Lending Rate Macro Model Exchange rate depreciates 29 Other Assumptions Deposit Rate 6 Months Time Deposit Proportion of Distressed Assets to Total Loan Proportion of Floating Rate Loans Proportion of Domestic Floating Rate Bonds Foreign Currency Denominated Debt 30 Role of Monetary Policy: Cont. Results : 1st round effect of a cut in the policy rate Interest receipt = -1,732 Mn Bt (- 46.7%) RP 14 day 1% Net Interest = -6,702 Mn Bt Interest expense = -8,434 Mn Bt (- 8.0%) ROA from 0.7 1.0 Interest Cover = 7.1% The accommodative stance of monetary policy has helped facilitate firm’s financial restructuring by providing liquidity and boosting profitability at least in the short run. 31 III. Finance and Investment Overall liquidity position improved, but a significant number of Thai firms remains relatively illiquid … (%) 50 40 30 20 10 0 32 Share of Listed Firms with Interest Coverage Ratio (%) of Less Than One, 1998 vs. 2000 1998 2000 2001 Philippines Malaysia Indonesia Source: Asian Economic Monitor (2001), ADB Thailand Korea 50 40 30 20 10 0 Similarly, with the pick up in the economy, more firms registered profits, but many continued to pile up losses. (%) 60 50 40 Percentage of Companies with Negative Returns, 1997 vs. 2000 1997 2000 2001 33 (%) 60 50 40 30 30 20 20 10 10 0 0 Philippines Malaysia Indonesia Source: Asian Economic Monitor (2001), ADB Thailand Korea Leverage ratio improved significantly, but still remains relatively high, signaling further restructuring needed. (%) 700 600 500 400 300 200 100 0 Debt/Equity Ratios, 1997 vs. 2001 (in percent) 1997 2000 2001 Philippines Malaysia Indonesia Thailand Korea Source: Author’s calculations for Thailand; Asian Economic Monitor (2001), ADB for the rest. 34 (%) 700 600 500 400 300 200 100 0 35 Finance and Investment • Traditional Models of Investment: Little role of financial factors - Tobin’s q: Market value of assets / replacement cost of assets. - M&M: Assume perfect market Investing and financing are independent. • Market Failure: Asymmetric information and Agency Cost - Asymmetric information: inability to differentiate good and bad firms - Agency Cost: potential conflict between owner, manager and debt holders 36 Implications: Higher costs of external fund relative to internal fund Firms’ financial structure influences investment Shocks to firm’s balance sheet / collateral value will alter dynamics of investment (Bernanke & Gertler (1989)) These problems should intensify during economic downturn. 37 Empirical Methodology: Panel data regression using fixed effects methodology for 187 listed non-rehab firms with non-missing data between 1994-2001 The estimating equation Cit 1 LAit 1 Dit 1 S it I it 1qit 1 2 3 4 5 K it 1 K it 1 K it 1 K it 1 K it 1 where: I = investment, K = capital stock, q = Tobin’s ‘q’, C = cash flows, L = stock of liquid financial assets, D = stock of outstanding debt, and S = sales 38 Aggregated Results Dependent Variable: Net Investment Rate (t) Explanatory Variables All Period (95-01) (1) All Period (95-01) (2) Pre-Crisis (95-96) (3) Crisis (97-98) (4) Post-Crisis (99-01) (5) 0.083*** (0.010) 0.07*** (0.011) 0.166*** (0.031) 0.072* (0.037) 0.108*** (0.025) -0.024 (0.058) -0.03 (0.058) 0.530 (0.395) -0.105 (0.168) 0.001 (0.053) Liquid Assets (t-1) 0.219*** (0.065) 0.201*** (0.066) 0.47** (0.191) 0.402** (0.18) 0.364*** (0.137) Debt (t-1) -0.195*** (0.032) -0.178*** (0.033) -0.014 (0.189) -0.363*** (0.090) -0.121*** (0.042) Sales (t) 0.131*** (0.017) 0.134*** (0.017) 0.391*** (0.058) 0.187*** (0.064) 0.104*** (0.025) Tobin’s q (t-1) Cash Flow (t-1) Cap. Util. (t) 0.0014** (0.0006) (*,**,*** denotes 10, 5, and 1 percent significant level, respectively) Disaggregated Results 39 Group by Leverage Ratio • Higher leverage firms are more sensitive to both debt and liquid assets than lower leveraged firms. Group by Size • Smaller firms are more sensitive to liquid assets than larger firms, while debt is significant only for larger firms. Group by Retention Rate • Higher retention firms are more sensitive to liquid assets and debt than lower retention firms. Overall Results generally support the view that financial factors influence investment and the impacts are varied by firm’s characteristics. 40 Extensions to other firms • Within SET: Rehab firms vs. non-rehab firms • Outside SET: firms tend to be smaller, less transparent, inferior quality of data and more bank dependence. Implications on Monetary Policy • Evidence of “balance sheet” credit channel of monetary transmission mechanism • Impacts of monetary policy are uneven across firm groups. • Though many factors influence investment, financial factors matter and deleveraging efforts should receive priority. 41 IV. Policy Recommendations 42 Policy Recommendations 1. Accelerate high quality debt restructuring 2. Improve corporate governance 3. Speed up capital market development for alternative funding sources 4. Enhancing corporate operational efficiency by improving the competition framework as well as encouraging a more active M&A markets 43 Strategy for Investment Recovery Renewed Credit Flows Strengthen banking system CG & Structural Reforms Improve confidence Enhance Efficiency Deleverage corporate sector New Investment Recovery 44 “In the end, the public determines the desirable sequencing of policy change. A decision to realize the efficient reallocation of resources all at once will be associated with significant pain but at the same time, it could pave a way for faster recovery later. To the contrary, a decision to realize reallocation in a gradual manner could avoid a sharp downturn, but it could delay a sustainable recovery. It is hard to say which approach is appropriate a priori. Having said that…the fact that the economy has recorded a low growth for 10 years or so, the shortcomings of the gradual approach are becoming more evident.” Yutaka Yamaguchi, Deputy Governor of the Bank of Japan