It's time to stop 'extending and pretending': Why Kuwait must really restructure its debt
Instead of confronting the gap between their assets and liabilities, and their flawed business model, companies secured debt agreements that prevented bankruptcy and proper debt work-outs (Pictured: Kuwait's The Central Bank of Kuwait).
The global financial crisis of 2008 is not yet over for many of Kuwait’s investment companies or for the Kuwaiti economy. Relying on short-term debt to fund illiquid assets, investment companies faced problems once the crisis hit banking sector turned off the financial tap. Instead of confronting the gap between their assets and liabilities, and their flawed business model, companies secured debt agreements that prevented bankruptcy and proper debt work-outs. Fortunately, the expiry of these debt agreements is an opportunity that Kuwait must seize to restructure the investment companies and unlock investment for the broader economy. Kuwait should instead take a new approach that will identify sound investment companies and close those that are insolvent in all but name. This is in contrast to the debt agreements, known as “extend and pretend,” that keep credit lines open, allowing investment companies not to recognize asset losses.
Kuwait’s legal and regulatory framework, which favors debtors, have supported investment companies and put them in a strong position with their bank creditors. Some companies have used “extend and pretend” to keep paying operating expenses. Stakeholders should follow a three-step process of separating viable from non-viable companies, sustainably restructuring debt, and liquidating non-viable companies in an orderly manner. This process will also restructure investment companies at a time when the banks are stronger and better capitalized, and so more able to absorb likely losses. The first step is for the authorities to create an independent task force that will distinguish between investment companies with a future and those that must close. The Central Bank of Kuwait (CBK) and the Capital Markets Authority should provide the mandate for the task force. Independence is vital so that the assessment of assets is accurate and honest. In the past, management in some investment companies did not provide frank appraisals of their assets. Such an independent inventory process will facilitate a comparison of the valuation and monetization possibilities for assets and the maturity of debt and liabilities.
The task force will be able to ask if companies have solvency levels that they can support or whether their equity has any value. It can judge whether there is sufficient recurring income from asset disposals, dividends, and fees, to service debt and cover overhead costs, and if there are funds for the business to keep operating and investing. The second step takes the viable companies and restructures their debt so that they can keep functioning. The point is to have sound information as a basis for action, creditors’ alignment, and innovative long-term solutions. There are two options available: out-of-court work-outs or workouts through the 2009 Financial Stability Law (FSL). Out-of-court work-outs require that the company initially seek an agreement based on the consensus of all its creditors. The regulators can assist in forging the agreement by acting as independent mediators and should not hesitate to become actively involved.
The CBK, in particular, can play a role. If no agreement is reached between the company and its creditors within three to six months, then an FSL work-out is needed. FSL proceedings, which have been little used, facilitate a court-approved restructuring and protect the investment company being pushed directly to bankruptcy by its creditors. The third step is to get non-viable companies out of the market. This means that shareholders have to confront the depletion of their equity and creditors have to accept haircuts (in which the market value of assets is reduced to provide collateral). Regulators have an important role to play. They should start involuntary liquidations if necessary. They should also be able to replace managers with external liquidators to oversee the closure of non-viable investment companies and the distribution of remaining assets to stakeholders. The regulators should also provide specific rules and guidance that enable shareholders to initiate voluntary bankruptcy proceedings. The losses in Kuwait’s investment companies have overshadowed the financial sector for too long. Creditors, shareholders, regulators, and managers should recognize that by cooperating they can end this uncertainty. By doing so, they will free up close to $40 billion of capital that could be productively used elsewhere in the economy.
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