Distressed Investing in Australia

A guide for buyers and sellers

About Blake Dawson
Our focus is getting to the heart of your legal needs and delivering you commercially astute and practical
solutions. We have a proud history, long standing client relationships, a passion for challenging conventions
and thrive on cutting edge work.
We provide legal services to Australia’s leading companies and institutions as well as global corporations and
government. We are privileged to work with many of the organisations that are shaping tomorrow’s industries.
Blake Dawson delivers more than just the law. We value our relationships with our clients and look forward
to working with you.

Our Distressed Investing Practice

Our Distressed Investing practice has an established track record of assisting clients to successfully execute
the restructuring, sale or purchase of distressed assets, companies and non-performing loan portfolios.
Our expertise spans all sectors including real estate, energy and resources, manufacturing and financial
services and we cover all geographic areas. We bring together a multi-disciplinary team of leading advisers
from our banking, restructuring and insolvency, corporate, property and tax teams to best structure your
distressed deals. For further information, please visit our website at www.blakedawson.com

About PricewaterhouseCoopers
PricewaterhouseCoopers provides industry-focused Assurance, Tax & Legal and Advisory services
for public and private clients in four areas:
• corporate accountability
• risk management
• structuring and mergers and acquisitions
• performance and process improvement
We use our network, experience, industry knowledge and business understanding to build trust
and create value for our clients.

Distressed Debt Group

Over the past decade, PricewaterhouseCoopers Distressed Debt Group has managed more than
150 sell-side and buy-side engagements in over 25 countries. Overall the group has acted for more
than 30 international clients, 60 local buyers and various government agencies.
With dedicated staff located in Australia as well as Asia, Europe and Latin America we bring together
global experience with local capability, no matter where the deal is, to ensure a smooth and seamless
experience. We are also uniquely positioned through our extensive relationships with the pool of global
investors, to ensure any deal is marketed to the widest possible audience of buyers.
The Distressed Debt group is an integral part of PricewaterhouseCoopers’ Corporate Advisory
and Restructuring practice which has a local presence in over 60 countries in the world.

© 2009. Blake Dawson and PricewaterhouseCoopers. All rights reserved.

This work is copyright. Reproduction of any part is welcome with prior permission from Blake Dawson and
PricewaterhouseCoopers. Requests and enquiries may be emailed to sarah.wilson@blakedawson.com and
duncan.mcgilligan@au.pwc.com.
Australian laws and regulations are constantly changing. This publication is intended only to provide a summary of
the subject matter covered. It does not purport to be comprehensive or to render legal advice. No reader should act
on the basis of any matter contained in this publication without first obtaining specific professional advice. We invite
you to contact us for any further information or assistance.
“PricewaterhouseCoopers” refers to PricewaterhouseCoopers, a Partnership formed in Australia or, as the context
requires, the PricewaterhouseCoopers global network or other member firms of the network, each of which is a
separate and independent legal entity.
Table of contents
Foreword – Blake Dawson 2

Foreword – PricewaterhouseCoopers 3

Overview – Distressed investing in Australia 4

1. The who, the how and the why of buying distressed debt/assets 12
Who buys and sells distressed assets, and why? How big is the global market? What is Australia’s
place in this market, and what do potential investors think of Australia? What is the secondary debt
market, and how does it operate in Australia and offshore?

2. Portfolio debt sales – the key considerations in value 18

What determines the value of a portfolio of an individual credit or a portfolio of distressed debt?
What are the key steps in the administration of distressed assets? How do debtholders recover
assets in Australia?

3. Using secured debt to control outcomes and obtain ownership of the assets 28
What are the legal boundaries within which distressed asset investors must move? What are the
rights and responsibilities of secured debtholders? How can debtholders best protect the value
of their assets?

4. Recapitalising distressed listed/unlisted companies 32

How can distressed asset investors recapitalise their assets? What are the differences between
listed and unlisted firms? How does the administration regime in Australia provide for companies
to be reorganised?

5. Why should an Australian bank sell debt? 36

If Australian banks have felt no need to sell distressed assets until now, why should they consider
it? Reasons include an increased number of buyers of distressed assets, the increasing drain
on management time and focus on workout, the constraints on capital created by Basel II,
and liquidity constraints brought on by the global financial crisis.

6. How does a non-performing loan portfolio sale work? 40

What are the steps in selling a non-performing loan, or a portfolio of loans? How are they priced
and how do sellers achieve the best price. What are the mechanics of servicing the portfolio
during and after the sale process? How can sellers best protect their interests?

7. Structuring options for sellers of debt/assets 46

How should banks and other sellers of debt structure their transactions? Options include outright
sale, a joint venture arrangement, or securitisation.

8. Tax implications of selling and buying debt 50

Tax issues are complex both for the buy side and sell side. What features of the Australian tax system
are relevant for distressed asset investment? What tax issues should sellers and buyers take into
account at the planning stage?

Appendix A – Economic outlook 62

Appendix B – Summary of Australian Big 4 Banks Basel II disclosures 64

Useful websites 66

Contributing authors 68

Contact information Back cover

 Foreword – Blake Dawson
The emergence and continued growth of a secondary market in Australia for
distressed debts and assets is a sign of the increasing depth and sophistication
of Australia’s financial markets.
Such a market is beneficial to the Australian economy for at least two key reasons.
Firstly, it adds much needed liquidity into the system, permitting parties with existing
positions to trade out those positions. Secondly, it creates a floor for distressed assets,
meaning that any business that is capable of being restructured is restructured.
Ultimately, by providing opportunities for new investors, the chances of preserving
stakeholder value and continuity of employment in Australian businesses are maximised.
For lenders and investors with existing positions, there is the option of selling
down their positions into the market. For potential investors with a knowledge
of distressed investing techniques, there is the opportunity to invest.
Australia is an attractive place to invest. The rule of law prevails and the legislative and
judicial processes are justifiably held in high regard. A number of the historical legal
impediments to secondary market trading have now been removed and the Australian
market is becoming more comfortable with the distressed investing techniques that are
common features of other markets; these include “loan to own” strategies; “pre-pack”
formal appointments; and convertible note investing. By utilising these techniques,
an investor can look to minimise the risks associated with investing in distressed
companies or their assets.
Of course there still remain issues that lenders and investors must confront. The
Sons of Gwalia decision, for example, has not done much for Australia’s reputation
in other financial markets where shareholders are expressly excluded from competing
with creditors upon insolvency. These issues aside however, distressed debt and
asset trading is a market not to be ignored. In a time of uncertainty, it presents
significant opportunity for those who have the appetite.
As market leaders in restructuring and distressed investing, we are committed
to shaping this emerging market. For this reason we have partnered with
PricewaterhouseCoopers to produce this guide. Covering the key legal and
accounting issues, we hope this guide will arm you with the requisite knowledge
and understanding to participate in and take advantage of this exciting market.

James Marshall
Partner, Blake Dawson

2
Foreword – PricewaterhouseCoopers
“When one door closes another door opens; but we so often look so long and so
regretfully upon the closed door, that we do not see the ones which open for us”
When Alexander Graham Bell wrote this world famous quote it is doubtful that he
had in mind the financial crisis of 2008/09.
The Australian market is today facing a period of uncertainty like it has not faced
since the early 90’s. Like then, globally banks today are facing a rapid build up
in non-performing loans and companies are facing unprecedented pressure on
their top and bottom lines. However the market is also a very different one today
to those uncertain days. In today’s market there are so many more options open
to both distressed companies as well as lenders.
There exists a very real opportunity for banks to unlock the hidden value tied up in
non-performing loans. From freeing up management time to focus on newer more
pressing problems to releasing capital that needs to be set aside against all NPLs,
debt sales have a very real place in today’s market as has been highlighted by the
American, European and Asian markets experience.
This is why, together with Blake Dawson, we have invested in this publication to further
develop the Australian market and to highlight some of the issues around the buying
and selling of distressed debt and assets and thereby encouraging the evolution
of this fledgling market in Australia.
Please read this with the open mind that Alexander Graham Bell advocates and
help us to help you realise this opportunity and in the end maximise recovery
during these uncertain times.

Michael McCreadie
Partner, PricewaterhouseCoopers

3
 Overview – Distressed
investing in Australia

“Australia is really attractive to us...”

...says the manager of a billion dollar global fund dedicated
to investing in distressed assets, who was interviewed for
the purposes of this publication.

Worldwide, distressed investment is a • The business operating environment is well

US$50 – US$100 billion industry. As the
consequences of the global financial crisis work
their way through the global economy, it is one
of the few areas that is set to grow significantly
in the years to come, as increasing numbers of
companies find themselves in difficult financial
circumstances and are unable to meet their
debt commitments. Distressed M&A in the
US alone is set to grow by 93% this year.
Australia will follow. The boom years have
been good to the lucky country, but the
global downturn has significant implications
for Australian companies. Export markets
are stressed and the domestic economic
situation has darkened. Companies are laying
off large numbers of workers, are restructuring
to avoid insolvency, and in some cases
are falling into administration.
For distressed asset specialists, Australia is
an extremely attractive market. Here’s why:
• Opportunities will proliferate as the economic
situation unfolds. The country’s banks are
managing a larger number of underperforming
loans than they have seen in 15 years.
Their workout teams are overwhelmed. In all
likelihood, the supply of non-performing loans
from Australian banks will multiply as banks
struggle with the new business conditions
and become increasingly comfortable with
the idea of bundling and selling poorly
performing assets to third parties
• The legal and accounting frameworks are
clear and comprehensible, unlike a number
of markets in the Asian region
regulated and stable, with good infrastructure
and well developed services
• There is a large base of sophisticated
investors looking for alternative investment
opportunities in this new and exciting market.
The distressed investing market in Australia
has historically been very quiet. But this is
likely to change, and change rapidly.
Between December 2008 and January 2009,
PricewaterhouseCoopers and Blake Dawson
interviewed a number of high profile market
participants, including representatives from
Australia’s major banks, foreign banks active
in the market, fund managers with experience
in distressed asset investing offshore,
and domestic private equity managers
considering distressed deals.
This overview outlines our conclusions from
those interviews together with research into
the opportunity for the creation of a secondary
or distressed investing market in Australia.
This publication outlines the mechanics of
such a market, from the basics of distressed
asset transfer to the structure of such deals,
its legal framework and tax implications.
Understanding how to participate in distressed
investing will be vital in the coming months
and years for those organisations that wish
to flourish through the downturn.

4
 Australian banks have never
really thought about debt sales.
They have never really had to.

Senior manager, major Australian bank

Background
Australia has had little need for a distressed asset market
until today. A strong economy for well over a decade
has meant there have been relatively few bankruptcies,
non-performing loans on bank’s books have been well
within manageable limits, and investors have had a wealth
of positive, growth oriented opportunities to focus on.

Now, we are on the verge of a new market.
A market created by the rapid change in
economic circumstances, by investment
capital looking for opportunities in an
extremely difficult environment, and by
the need for Australian banks and other
financial institutions to find solutions
to new problems.
Through a period of 15 years of
uninterrupted growth, Australian lenders
have experienced only modest levels of
financial distress amongst their customers.
Financiers in other parts of the world have
developed efficient markets for transferring
distressed assets off their balance sheets
to specialist investment funds and other
investors dedicated to the sector. But
their Australian counterparts have been
under no pressure to do so.
With the global financial crisis rolling
through the Australian economy, financial
institutions are likely to see a sharp
increase in non-performing loans and
other distressed assets. At the same time,
banks’ revenues are reducing because of
lower demand for credit, and there will be
greater pressure from both shareholders
and regulators to hold increased amounts
of capital against impaired assets.
Meanwhile, distressed asset funds
operating across international markets
are eyeing Australia carefully. The country’s
well structured financial markets, rigorous
legal frameworks and clear regulatory
environment give it a competitive
advantage over its regional neighbours,
and a clearly imminent increase in
financial distress is attracting attention
from those who seek to extract value
from financially troubled companies.
Global funds with experience in distressed
markets are cashed up and poised on
the sidelines. Over the next few years,
Australia may well see the birth of a
vibrant market for these assets, but it
will take a change in approach on behalf
of the major financial institutions, and a
few breakthrough deals to kick start it.
Bad news rising
At the tail end of a 15-year boom, the
Australian economy is facing numerous
challenges. Seemingly overnight, the
credit crunch and the global financial
crisis have brought the country’s longest
unbroken period of growth to a halt.
The years of relatively easy credit that
fuelled the country’s optimism and its
investment in the future have ended.
In 2006, companies were offered
unprecedented amounts of leverage
to finance their futures and maintain
smooth cash flows. Much of that

5
 activity came to a stop in the middle
of 2007 as banks faced serious liquidity
challenges in the flow on from the sub-
prime crisis in the US. The early stages
of the credit crunch saw the collapse
of many Australian companies whose
rise had been emblematic of the boom:
Allco Finance Group, ABC Learning,
Centro and Babcock & Brown being
the highest profile casualties to date.
The spread of bad news through the
financial markets has infected broader
sentiment throughout the economy.
Companies, for many years unable
to recruit enough good people fast
enough, have been laying workers
off in their thousands. Consumers,
a mainstay of Australian prosperity for
over a decade, have stopped shopping.
Despite fast and deep cuts in official
interest rates by the Reserve Bank of
Australia, industry has stopped investing
and the housing market has stalled.
China, whose economic health has been
crucial for Australia, has also faltered in
recent months, its export-led GDP growth
stumbling from over 10% over the last
decade to less than 7% at the end of
2008. China’s unprecedented demand
for commodities placed a floor under
prices for much of Australia’s inventory
of natural resources, and underwrote
soaring share prices for the country’s
blue chip mining companies and a flurry
of investment in small and medium
sized commodity enterprises.
China also directly invested tens of
billions of dollars in Australian resource
enterprises. Much of this investment is
under pressure to continue to perform.
The collapse in China’s export markets
is rapidly flowing through to the Australian
6
mining community, and that sector, just
12 months ago the source of a great
deal of economic strength, is undergoing
swift and unpleasant adjustment.
In short, the credit crisis is having a
significant impact on Australia’s industries
and enterprises. Many companies with
previously sound business models
have met with unexpected difficulty
when attempting to roll over their short-
term loans, causing sudden and severe
cash flow issues. Many have had to
quickly and radically adapt their business
operations. Others have simply failed.
According to the Australian Securities
and Investments Commission, the number
of companies entering administration in
Australia jumped 10.3% between 2007
and 2008 to 8,300, and the number
of insolvency appointments jumped by
over 6% to 12,770.
Bad loans in the system
With the economy in freefall, banks and
other financial institutions are bracing
themselves for a major increase in
distressed assets as companies and
consumers find themselves unable to
service the loans taken on in the good
times. By the end of the last fiscal year,
the major banks had already seen a rise
in bad debt charges, up some 174% over
the year to end June 2008. The first half of
calendar 2008 was 54% higher than the
second half of 2007. By some measures
the increase in bad debt charges in fiscal
2008 was up 183%, representing 0.41%
of total loans. The Australian banking
industry hasn’t seen this level of bad
debt charges since 1994, the tail end
of the last downturn.
Our conversations with the major banks
indicate that many workout desks are
already feeling the pressure.

Michael McCreadie, PricewaterhouseCoopers

IMPAIRED ASSETS AND BAD DEBT EXPENSE

7.0% 2.5%
Impaired assets / gross loans & acceptances (left axis)
Bad debt charge / gross loans & acceptances (right axis)
6.0%
2.0%
5.0%

1.5%
4.0%

3.0%
1.0%

2.0%
0.5%
1.0%

0.0% 0.0%
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Notes: 2006 onwards based on AIFRS

Source: PricewaterhouseCoopers – Perspectives: Major Banks Analysis, October 2008

DOMESTIC CREDIT GROWTH

(ANNUAL % GROWTH)

30%

25%

20%

15%

10%

5%

0%
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Total Housing Personal Business

Source: PricewaterhouseCoopers – Perspectives: Major Banks Analysis, October 2008

7
 At the same time, the banks have
witnessed a marked increase in
impaired assets, up by 137% in fiscal
2008, or 0.43% total loans. While this
is still significantly below levels experienced
during the 1990s, the banks are also
seeing significant increases in past-due
loans. During fiscal 2008, loans that were
“past due 90 days or more with adequate
security” increased 29% in aggregate.
Our discussions with a number of
workout professionals in the major
banks indicate that many are facing
unprecedented workloads. In many banks,
workout desks are perhaps the only
growing part of operations, with many
experiencing such growth in demand
they fear being overwhelmed.
While impaired assets and debt charges
are likely to increase significantly, bank
margins will be under pressure from
slowing credit growth on both the
consumer and business lending sides.
Total credit growth slowed in 2008 to
10.5% from 16% in 2007, with growth
in business lending slowing to 13.7%
in the year to September 2008 from
over 22% the previous year.
This points to a challenging environment
for the major banks, to say the least.
Things are likely to be worse for other
players in the financial services arena.
The foreign banks, second tier financial
institutions, such as smaller banks, credit
unions and building societies, as well
as other non-bank financial institutions
are each facing their own issues
and financial strains.
A fear exists that foreign banks, under
pressure to withdraw capital to support
their home markets, will pull out of the
Australian market, transferring their
Australian loan portfolios, in aggregate
totalling some A$50 billion to A$80 billion,
to other counterparties or reducing
8
funding lines. At the time of publication,
reports were emerging of the first of
such activity, with a major foreign bank
offering a portfolio of leveraged loans
of up to A$100 million.
In response to the feared pullout of foreign
banks, in January 2009 the Australian
government launched a A$4 billion fund to
support commercial property development
projects that lose their international
financial backing due to the financial
crisis. Domestic banks will provide half
the fund’s capital.
Many second tier banks and other
smaller financial organisations are
seeking consolidation or other forms
of partnership with larger institutions.
Non-bank financial institutions have been
significantly weakened by the increase in
the cost of funding, as well as the collapse
in demand for housing finance with the
fall in house prices.
Each of these issues creates new
pressures on Australia’s financial system
whose most marked characteristic over
the past decade has been swift growth
and fast innovation.
Distressed assets
A significant volume of distressed debt
is an unfamiliar problem for Australian
lenders. Australian financial institutions
have generally adopted a much simpler
business model than their counterparts
offshore. While banks and other financiers
in the US, Europe and Asia have actively
managed their balance sheets by selling
individual loans or portfolios of non-
performing loans (NPLs) and other
distressed assets to realise value and
transfer them off their books, Australian
banks have not done so, resolutely
keeping bad loans on their own books and
focusing on working them out themselves.
The full impact of Basel II is really unknown
as yet as we have not lived through a cycle
with it. If the full impact is applied, then there
is no way banks can afford to carry NPLs on
the balance sheets during the tough times.

Senior manager, major Australian bank

Australian bankers, when interviewed about the lack of a local

market for distressed assets cite several reasons, the most
persistent of which is that there has been no real need for one.
“Australian banks have never really thought about debt sales,”
said one senior manager at a major Australian bank. “There may
be a number of reasons for this. It may be that the structure of
Australian loans – the documentation – has precluded trading
them. Secondly, banks may have had the view that they would
be foregoing too much profit were they to transfer their assets.
And thirdly, because of their position in the community, banks
would be reluctant to hand their customers over to a distressed
asset firm that may not have the same relationship imperative.”
Other reasons given include a cultural reluctance to admit
mistakes, as well as a focus on workouts as a core banking
competence that precludes the sale of NPLs.
None of these reasons would seem strong enough to dissuade
banks from entering into an active distressed debt market if the
volume of NPLs reached critical mass. As workout desks become
increasingly overwhelmed, as investors begin to offer prices that
reflect the fair value of the loans, banks will be forced to consider
the alternative to keeping all NPLs on their balance sheets.

Capital questions
Over and above the pressure banks are likely to feel from
increasing volumes of distressed assets, regulators will have a
keen eye on banks’ management of capital. The introduction of
the Basel II regulations this year will increase scrutiny of banks’
NPL portfolios. There is growing concern among the banking
community that both the banks and the regulators do not “We see a market waiting
yet appreciate the full impact of the new regulations as levels
of NPLs increase significantly.
to come to life.”
Basel II requires banks to set aside up to 25% of the gross Michael Sloan, Blake Dawson
loan value of NPLs as Tier 1 Capital, capital that could be freed
up to generate income for the bank in other ways if the NPLs
were sold to another party.
According to one senior banker: “If the full impact of Basel II
is applied, there is no way banks can afford to carry NPLs on
their balance sheets during the tough times.” He points out
that the Basel II regulations, if fully imposed, are extremely
pro-cyclical, discouraging banks from lending during
downturns, and freeing up capital during boom times.

9
 Distressed corporates
The distressed market is not just
confined to the impaired loans of
Australian banks. Many listed and private
Australian companies and trusts are
experiencing severe liquidity problems
associated with looming refinancing dates
and a lack of replacement debt capital.
To date, some larger listed corporates
have managed to reduce gearing and raise
liquidity through cut price raisings on the
equity market which, whilst dilutive, is a
better option than the other alternatives.
However, for private companies and listed
companies with weak share prices, this
option is generally not available. A number
of off-shore and domestic funds and
lenders are now targeting distressed
corporates and offering them relatively
highly priced debt (usually with a right to
convert to equity upon agreed terms) to
fund liquidity gaps. Such funds will also
consider investing equity but will seek
assurances around the balance sheet
and matters such as class action risk.
Demand for distress
Banks are indeed likely to consider selling
their distressed assets in the near future.
At the same time, there is significant
demand for them from both global players
based in Asia and local private equity
players looking to deploy their funds in
the distressed asset arena. The market in
Asia has been active since the late 1990s,
when the number of distressed companies
shot up in the Asian financial crisis. Across
the globe, there are hundreds of entities
that invest in distressed assets, from
the major international players out of the
10
US, such as Cerberus and Lonestar, to
smaller specialist funds, many of which
have pan-Asian funds that would consider
Australia and New Zealand part of
their investment universe.
A survey of 100 hedge funds across Asia
by Debtwire in October 2008 found that,
after China and Indonesia, Australia is
the market where most distressed debt
opportunities are expected to arise over the
coming year. At the same time, Australia’s
strong legal framework and regulatory
environment give potential distressed asset
investors security in their property rights,
an advantage over the less predictable
Chinese and Indonesian markets.
“There are a number of things we like
about Australia,” says one manager at
an international alternative investment
fund. “Firstly as a global fund we like
the language, the law and the corporate
governance framework. At the same
time, because we deal with distressed
assets we can see there are some real
problems brewing in the underlying
economy – so we are likely to see
some opportunities arise there.”
“The country also has a greater level
of sophistication in terms of asset
management networks. We are a capital
provider, and can’t service individual loans
from a pool of them. Rather, we need to
tap into an existing infrastructure to help
us manage our assets, and that exists in
Australia, whereas it doesn’t in some of
the less developed markets in Asia.”
A point made by many asset managers
was that, because many funds operate
on a global basis, any investments in
Australia would have to offer risk-adjusted
rates that were competitive with those
There are a number of things we like about
Australia. Firstly as a global fund we like the
language, the law and the corporate governance
framework. At the same time, because we deal
with distressed assets we can see there are
some real problems brewing in the underlying
economy – so we are likely to see some
opportunities arise there.

Manager, international alternative investment fund

attained in other parts of the world. At the
moment, there is an impression that there
is something of a large spread between
what sellers of distressed debt might
offer, and what buyers might pay.
“My feeling,” says another distressed
asset specialist operating across Asia,
“is that the market in Australia is still in
price discovery mode. There is a fairly
large bid-ask differential.”
At the same time, asset prices across
the globe have been falling steadily since
mid-2008, and many investors are sitting
on the sidelines waiting to see when
a bottom might be found.
The picture is one of a market waiting to
come to life. On the supply side sit the
banks, with a growing pool of distressed
assets that will need to be managed for
value, but constrained in their ability to
expand workout operations by supply of
experience. They are also limited in their
capacity to hold NPLs by the need to set
aside significant amounts of regulatory
capital against them. On the demand side,
there are a large number of funds with
considerable amounts of capital available
ready and willing to invest in these assets.
With a change in approach from Australia’s
major banks, an adjustment in price
expectations from both sellers and buyers,
and a detailed understanding of the legal
and business issues discussed in the
rest of this publication, we anticipate the
creation and growth of a real market for
distressed investing in Australia over the
next few years. This growth will benefit
banks, investment funds, and, in the end,
companies experiencing financial distress
to have an efficient market focused on the
ownership and management of their debt.

11
 1. The who, the how
and the why of
buying distressed
debt/assets
The distressed debt market in Asia matured during the late
1990s as numerous countries in the region went through a
period of economic turmoil. The Asian financial crisis threw
up many “distressed opportunities” offering alternative
investors above average returns. These opportunities,
combined with a flattening of returns in the US/Latin
American distressed markets focused investors’
attention on the Asian markets.

The initial influx of buyers came primarily
out of the US and included larger players/
funds such as Cerberus and Lonestar,
and finance houses such as GE. Target
acquisitions included large secured NPL
portfolios, real estate and large corporate
debt. As the economic crisis worsened
more opportunities arose across Asia and
especially in countries such as Taiwan,
Japan, Korea, Thailand, Philippines,
India, China and Malaysia. With early
deals reportedly generating significant
returns, the market for distressed
debt quickly grew and the number
of “players” expanded exponentially.
While statistics vary, in today’s market
there is estimated to be hundreds
of investors involved in the distressed
debt market. The major distressed debt
investors have been around since the
early 1980s and have developed unique
skills and expertise in valuing, buying and
managing distressed debt acquisitions.
Initially the majority of distressed debt
investors originated in the US and
Europe, but the growth of opportunities
in Asian markets in the last 10 years
has seen the emergence of numerous
Asian-based buyers focusing solely
on Asian opportunities.
The current global economic turmoil has
seen a number of funds pull out of the
market and others take a very cautious
approach to investing. To quote a common
phrase, no one wants to catch a falling
knife. Our discussions with investors
have indicated that while this was the
general consensus in 2008, most expect
to revisit these views in 2009. Also it
would seem that established buyers are
looking to raise new funds and capitalise
on the movement of capital away from
traditional areas to distressed investing.
The chart on page 36 indicates the extent
of raisings by distressed funds over the
past couple of years.
A unique characteristic of the current
economic turmoil is the true global nature
of the downturn. Previous downturns have
focused on particular regions and hence
distressed investors focused on particular
markets. An issue for Asia Pacific sellers
is that due to the state of markets in the
US and Europe, the big global distressed
investors who work with a global pool of
capital will focus their attention wherever
the best returns can be achieved.
Currently this is in Europe and the US.
For the market in distressed debt to grow
in Australia, pricing and returns will have
to be comparable with global valuations.

12
Established buyers are looking to
raise new funds and capitalise on
the movement of capital away from
traditional areas to distressed investing.
How are investors classified?
Distressed investors can generally be classified
into the following three categories:
1. Distressed debt funds
(Hedge funds, private equity funds)
This category is made up of those buyers that have a
primary focus on distressed debt or assets. Many of
the early players in the distressed market were funds
established by ex-investment bankers with wealthy
clientele looking for above average returns. Historically
these funds have been subject to minimal regulatory
control and have therefore been able to preserve high
levels of confidentiality. In Asia at present there is a
large number of these types of funds ranging in size
from the small with more than US$50 million to invest
to the large with over US$1 billion available to invest.
In the current climate these funds are typically looking
for opportunities where they can bring to bear their
financial skills, such as restructuring a company to
maximise their returns. Typical investment size across
Asia is US$10 to 25 million while some of the larger
funds will look at US$100 million plus opportunities.
Return requirements are generally in the 25% plus
Internal Rate of Return (IRR) range. While usually
distressed funds prefer to invest on their own rather
than in a joint venture structure, in the current climate
structuring deals including joint ventures are becoming
more popular as a means to mitigate exposure and
enhance value to both the buyer and the seller.
New entrants into the market have been the
traditional Private Equity firms. As the number of
traditional private equity deals have slowed or the
risks and rewards have become relatively unattractive,
alternative forms of investment are being investigated.
Traditionally private equity has purchased equity as
a means to assume control; however the distressed
investing model of using the debt structure to secure
control with added security is becoming increasingly
attractive for those funds that still have cash.
The majority of these funds are offshore, but a number
of new funds are setting up in Australia.
2. Financial institutions
(including investment banks,
commercial banks and financial houses)
Many financial institutions have “special situation
groups” focusing on distressed debt investing.
Typically these operations form part of the bank
and often focus both internally and externally.
For example, a special situations group can help their
parent institution with their own non-performing loans,
can help expand customer bases by purchasing non-
performing loans from other financial institutions or
can invest their own funds.
Some of the more consistent investors here include
Morgan Stanley, JP Morgan, UBS, Goldman Sachs,
Merrill Lynch, Standard Chartered, Standard Bank,
Deutsche Bank, HSBC, Citibank and GE.
These investors tend to have higher investment size
preferences in the range of US$15 to 20 million plus.
3. Local buyers
Both categories 1. and 2. are generally foreign
investors, as typically their focus is cross border,
i.e. they will look to invest in multiple countries
within a region.
Given the growth in distressed debt opportunities
in Asia over the last 10 years, a number of “local
operators” have been established to focus on specific
country based opportunities. A good example of
these are government supported entities established
to resolve local bank non-performing loan problems
such as the Asset Management Companies (AMCs)
established in China, Thailand, India and Vietnam.
In Australia a number of local servicing companies
have also looked to purchase NPLs mainly focused
on the consumer credit card space and generally
on a forward flow basis.
13
 COUNTRIES RATED ON THEIR DISTRESSED DEBT OPPORTUNITIES IN 2009

China 65 17 8 4 4
Indonesia 49 23 15 11 2
Australia 38 22 22 16 2
South Korea 36 16 31 13 4
India 25 25 29 17 4
Thailand 16 27 36 16 5
Vietnam 21 18 41 15 5
Philippines 17 24 37 17 5
Japan 12 21 43 19 5
Malaysia 14 17 43 19 7
Taiwan 9 21 47 18 5
Hong Kong 12 20 32 34 2
New Zealand 3 14 54 26 3
Singapore 8 13 36 28 15
0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
Percentage of respondents

Significant Very High High Low None

Source Debtwire: Asia-Pacific Distressed Debt Outlook 2009, December 2008. Survey canvassed 100 hedge fund
managers and proprietary trading bankers.

Investors focus on Australia Types of investments

The attractiveness of the Australian market
to distressed investors is highlighted by the
Deal types
chart above – 60% of the 100 investors Most distressed debt investors
surveyed throughout Asia had “significant” will look at a range of deal types
or “very high” potential for distressed debt including the following:
opportunities in 2009. The same survey
• NPL portfolios sold by banks (either
found China and Indonesia (the only two
secured or unsecured, although secured
countries rated more highly for distressed
portfolios tend to attract more interest)
opportunities than Australia) to be the
countries where it is most difficult for • High yield lending
creditors to exercise or enforce their rights
• Equity investments, often coupled
over security or to enforce their rights in
with high yield lending, particularly
court. As a result, Australia is very much
in the real estate sector
on investors’ radars.
• Equity investments and/or high
The added attraction of the Australian
yield lending, in private companies
market is the strength of the regulatory,
or State Owned Enterprises (SOEs)
legal and governance environments.
often combined with management
As one investor mentioned, “when we
influence (e.g. seats on the board)
walk into an Australian court the chances
of us getting subjugated to a lower asset • Distressed real estate or real estate
class is pretty unlikely.” In comparison to seized by financial institutions and
other Asian markets, Australia’s strong subsequently offered for sale
legal and regulatory framework provides
a relatively high level of comfort and • Single credits of distressed debtors
security for investors. • Credit card portfolios or other
types of “receivable” portfolios
(such as utility debts)
• NPLs or NPL portfolios on
the secondary market.

14
Assessment approaches
While each of the above investment
types will require a different “assessment”
approach, typically investors will consider
the following issues in relation to each
potential transaction:
• Determining an exit strategy
– depending on the nature of the
investment, exit strategies may
range from regular debt repayments,
foreclosure actions, sale of assets or
realisation of equity holdings
• Estimating future cashflow – what are
the timings and total expected gross
cashflow amounts generated by the
proposed exit strategy, for example
the timing and amount of forecast debt
repayments or the realisation of assets
• Estimating costs to be incurred
in relation to the adopted exit strategy
such as outsourced collection costs or
the cost of establishing a local presence
• Agreeing on the desired required return
factoring in the cost of debt/equity and
estimated risk to the investment.
Key elements
While each investor has a specific
“investment decision matrix” and
a “preferred investment type”, the
key elements that they all look for
in any transaction include:
• Reasonable transaction size relative to
the fund size, i.e. the effort to be put
into a deal needs to be justified through
a meaningful investment amount.
Typically the average investor is looking
at deal sizes (across Asia) of between
US$10 to 25 million with larger investors
looking to allocate up US$100 million
on a deal by deal basis
• Access to reliable and current data with
which to make the investment decision
• Certainty of a transaction taking place,
especially in the case of a NPL sale
by a bank
• A clear exit strategy including a relatively
predictable timeframe. In this regard
some investors look for a relatively short
turn around such as less than 1 year
while others prefer longer timeframes.
It is not uncommon for distressed debt
investments to have an average life
of 2 to 4 years
• Above average return requirements –
while return requirements vary between
investors and for each investment type,
all distressed investors are looking
for above average returns.
15
 Secondary debt trading terms
Traded distressed debt includes secured and
unsecured bank debt, trade debts, liquidated
and unliquidated damages claims and other
choses in action.
The transfer of economic risk associated with a debt
may be achieved either by transferring the debt itself
so that the purchaser of the debt enters into a direct
relationship with the debtor or by sub-participation
of the debt in which case the purchaser assumes
the economic risk associated with the debt pursuant
to a contractual relationship with the seller only.
Debt transfers are normally carried out by legal
novation or assignment and the mechanism for
transfer is likely to be set out in the relevant loan
documentation. Any such transfer must be carried
out in accordance with the terms of the loan
documentation which may include restrictions on
the minimum amount of debt that can be transferred
or the nature of transferees. For instance, it is
common for loan agreements to include provisions
providing that the debt may only be transferred
to another financial institution.
Sub-participation is more flexible because the
debtor is not party to the arrangement and
has no influence on the terms. For this reason,
portfolio sales are likely to be carried out by
sub-participation. Sub-participations can be funded
(the purchaser makes payment upfront) or unfunded
(the purchaser indemnifies the vendor in the
event of a payment default).
A funded sub-participant assumes a credit risk
on the seller whereas in the case of an unfunded
sub-participation the seller assumes a credit risk
on the purchaser.
Sub-participants are also exposed to increased
cost risk and withholding tax risk as they do not
receive the benefit of the protections under the loan
agreement. Similarly a sub-participant will not be able
to access market disruption provisions.
16
Where only part of a particular debt is sub-participated
a key issue will be how voting rights under the relevant
loan are executed. Generally, the lender of record
will not be able to split its vote so voting rights will
generally go to the institution with the largest exposure
subject to consultation. However, in some instances
where the lender of record is keen to protect a client
relationship it may be reluctant to cede voting control
even to a sub-participant of the majority of its debt.
Other important considerations in distressed debt
trades are whether the sub-participant has the ability
to force a transfer of the debt to it and whether it
receives an interest in ancillary rights to the debt
(e.g. claims against advisors in respect of reports
provided to the vendor).
In distressed debt trading a central issue of focus is
whether the purchaser is taking the risk only on the
level of return or on the risk of the validity of the claim.
Often the vendor will retain the risk that the claim
is rejected by a liquidator.
The Asian secondary debt markets (including
Australia) have not yet developed their own
standard documentation or terms for distressed
debt trading, but the Asia Pacific Loan Markets
Association is seeking to progress standardised
documentation for Australia. For most trades within
these markets, parties typically adapt local par debt
trading documents using distressed debt terms
from the US market (Loan Syndication and Trading
Association (LSTA) terms) or the European market
(the Loan Marketing Association (LMA) distressed
debt trading terms). Standard documentation
available includes risk transfer documentation and
associated documents for carrying out a debt
trade such as confidentiality arrangements.
 Perspective

• The unique characteristic of the current economic turmoil is the global

nature of the downturn. Major global distressed investors will focus
their attention wherever the best returns can be achieved. Australia’s
advantage is the strength of our regulatory, legal and governance
environments, which offer security for investors.

• Sellers of distressed debt need to know about likely buyers (who

generally fall into three main categories: foreign distressed debt
funds, foreign financial institutions and local buyers), their return
requirements, their preferred investment types and approaches,
how they make their investment decisions and the key elements
of what they look for in a transaction.

• Important considerations for both buyers and sellers are the

secondary debt trading terms and the transfer of economic
risk associated with a debt. Any transfer must be carried out
with the terms of the relevant loan documentation.

• The Asia Pacific Loan Markets Association is seeking to

progress standardised documentation or terms for distressed
debt trading for Australia. Currently parties typically adapt local
debt trading documents from the US or the European standard
terms. Standard documentation available includes risk transfer
documentation and associated documents for carrying out a
debt trade such as confidentiality arrangements.

In comparison to other Asian markets,

Australia’s strong legal and regulatory
framework provides a relatively high level
of comfort and security for investors.

17
 2. Portfolio debt sales –
the key considerations
in value
There are many interlocking factors that will determine
the value for the transfer of a loan portfolio.
The factors that will impact pricing include:
• The credit approval process
• The quality of the portfolio
• The type of sale
• The quality of information
• The timing of the sale.
The risks posed by each of these factors
can be minimised by ensuring a robust
and transparent process.
The main variables that will be considered
by the buyers include the following:
• How much of the individual debt
will be recovered?
• How long will it take to collect?
• How much will it cost to collect?
• What is the risk associated with the
debt recovery process?
The key considerations are summarised
in the diagram below.
A BUYER'S KEY CONSIDERATIONS
How much
will I collect When will
and from I collect?
what sources?
18
How much of the individual
debt will be recovered?
The key determinant of value will be
the proportion of the outstanding debt
that can be realistically recovered
from the borrower.
Corporate loans
For corporate loans the first question
is whether or not the loan is secured,
and if so, what is the realisable value
of the underlying security. The key issue
here is how current is the appraisal.
Once a floor has been set on the loan
value the next question to be addressed
is whether the borrower is likely to seek
to restructure the loan. Issues that need
to be taken in to account include:
• Are there personal guarantees?
• Are there director liability issues?
• Who has provided the guarantees?
• Is the company still trading?
Servicing Discounted
and for return
Management requirements Valuation
Costs (incorporating
leverage)
The emergence and continued growth of a
secondary market for distressed debts and
assets is a sign of the increasing depth and
sophistication of Australian financial markets.

James Marshall, Blake Dawson

Addressing each of these questions will How long will it take to collect?
assist in determining if a restructuring
Any purchaser of debt will factor in the
or renegotiation of the debt will be
time value of the investment, and discount
possible. If a restructuring or discounted
the future payment stream back to present
pay out is not possible then how
value. Assumptions regarding the time
much of the loan over and above the
it is likely to take to recover the debt will
security is recoverable? Some of the
have significant influence on the overall
issues here include whether there are
valuation. There are a number of factors
guarantees in place, what assets are
that will be key, including:
behind the guarantors and where are
the guarantors located? • What restructuring or discounted
payoff is to be put in place,
and over what period?
Consumer loans
• How long will it take to foreclose
For consumer loans the questions
on a property?
are similar:
• What are the potential impediments
• Are the loans secured, and if so,
to enforcing security?
what is the realisable value of the
underlying security? • How long is the typical bankruptcy
process for corporates or individuals?
• What are the chances of renegotiating
the loans? • How long does it take to sell assets?
• What are the chances of recovering • How far through the recovery process
any of the shortfall after realising is the seller?
the security?
• For unsecured loans what are the Australian
chances of recovering any amount
from the borrower?
insolvency procedures
The main steps in each of the major
• What is the likely timing of any
formal recovery procedures in Australia
liquidation dividend?
are outlined below.
To determine the likelihood of recovery,
borrower characteristics such as age, Administration
sex, location and employment status
Voluntary administration is the most
must be assessed. Other factors
common formal corporate rescue process
influencing recoverability will be the
used in Australia. It is most often initiated
type of loan and what it was used for
by the directors of the company because
and what sort of recovery process has
the appointment of an administrator
the loan been through?
will relieve the directors from any risk
of personal liability for insolvent trading
in relation to debts incurred following
the appointment of an administrator.
An administrator can be appointed by
the directors (by resolution), a liquidator
of the company, or the holder of a fully
secured charge over the company.

19
 Administrators are given wide powers
to control and manage the company,
and the directors are not permitted
to exercise any powers except with
the consent of the administrator.
The appointment of an administrator gives
an independent insolvency practitioner
the power to administer and conduct the
company’s business. Administrators are
given wide powers to control and manage
the company, and the directors are not
permitted to exercise any powers except
with the consent of the administrator.
The administration process under
Australian law is driven by the votes of
unsecured creditors at creditor meetings.
Courts do not supervise the process
but can adjudicate on issues that arise
upon the application of interested parties,
including the administrators. Whilst
in administration, statutory moratoria
prevent proceedings against the company
being commenced, charges being
enforced against the company (subject
to a 13 day decision period for holders
of full security) or property being recovered
from the possession of the company,
except in certain circumstances.
20
However, there is no moratorium
preventing contractors from terminating
their contracts on the basis of an
insolvency event clause. In many cases
contracts will contain default provisions
which allow for termination upon the
appointment of an administrator.
The administrator must generally
report to the creditors, in writing,
within 30 business days of appointment
specifying the options for the company’s
future. The options are either a deed
of company arrangement, liquidation
or return of the company to the control
of the directors. The report will contain
the administrator’s recommendation
as to which option is in the
creditors’ best interests.
THE KEY STEPS AND TIMELINES FOR VOLUNTARY ADMINISTRATION
Action
Notice of appointment sent to creditors
First meeting of creditors
Second meeting of creditors
Adjournment of second meeting of creditors
Given the extensions which may be made
to the timing of the second meeting of
creditors, in complex administrations
it may take between 3 and 12 months
before the company’s fate is voted upon.
At the second meeting of creditors, the
creditors vote on whether the company
should enter into a deed of company
arrangement, be liquidated, or returned to
the control of the directors (a majority vote
is counted in terms of numbers and value).
Significantly, no court approval is required.
If a deed of company arrangement
is entered into, the limited statutory
requirements allow tremendous flexibility.
Deeds can be used to implement almost
whatever type of arrangement the situation
requires – from a simple compromise of
debts to a complete corporate restructure,
a capital raising or a continuation of the
business. Recent reforms have also
enhanced this flexibility by facilitating
post-restructuring equity raising
and debt financing.
Timeframe
5 business days from appointment
8 business days from appointment (omit the first day)
Up to 30 business days from appointment
Permitted for up to 45 business days with creditor approval;
further extensions possible with court approval
Where the creditors accept a proposal
that the company is to continue to trade,
the execution of the deed of company
arrangement marks the end of the
administration. The terms of the deed
replace the statutory moratorium on
company debts and the arrangement
binds all of the company’s creditors,
shareholders, directors, the company
and the deed administrator.
Administration and
Chapter 11 compared
Overseas investors are often interested
to compare Australia’s voluntary
administration regime with the
United States’ Chapter 11 procedure.
The table on page 22 highlights the key
similarities and differences between
Australia’s voluntary administration
and the United States’ Chapter 11
regimes, based on the Australian
Government’s, Corporations and Markets
Advisory Committee, Discussion Paper,
‘Rehabilitating large and complex
enterprises in financial difficulties’,
September 2003.
21
 AUSTRALIA’S VOLUNTARY ADMINISTRATION VS US CHAPTER 11 PROCEDURE
Prerequisites
Who can commence
the procedure?
Benefits in appointing
Role of the court
in commencing
the procedure and
approving the plan
Who controls the
company during the
rehabilitation procedure
Committees or creditors
Information to creditors
Moratorium on claims
against the company
Ability of contract
counterparties to
enforce ipso facto clauses
Ability of creditors to
exercise set-off rights
Liability for
goods and services
Ability to
disclaim contracts
Avoiding prior transactions
Loan financing during
rehabilitation procedure
Who devises
rehabilitation plan
Duration of
exclusivity period
Approval of
rehabilitation plan
Majority required to
approve the plan
Rehabilitation plan binding
secured creditors
Rehabilitation plan
discriminating between
creditors
22
Australia – Voluntary administration
Insolvency or likely insolvency.
The directors, a liquidator or provisional
liquidator or a substantial chargee.
Directors can avoid incurring liability
for insolvent trading.
Recent amendments enhance flexibility
in balance sheet restructuring.
No mandatory role in either situation, though
the court has various ancillary powers
exercisable on application.
The administrator, who must be a
registered liquidator.
Limited functions, namely to consult with
administrator in relation to the administration
and consider reports by the administrator.
Report by the administrator about the
company’s business, property, affairs
and financial circumstances and a
recommendation about what is to be done.
Automatic moratorium, with significant
exceptions for some secured creditors
and property owners.
Yes.
Yes.
Administrator personally liable, with a right to
an indemnity out of the company’s assets.
Company can generally repudiate
contracts, with counterparty ranking
as unsecured creditor.
Administrator cannot avoid
pre-administration transactions.
Lender is an ordinary unsecured creditor
of the company, but recent legislative
amendments allow for priority to be
adjusted with secured creditors’ consent.
The administrator, although other parties
can put forward proposals.
Approximately 1 month, subject to
the court extending the period.
One meeting of all creditors.
50% majority by number and by value of all
the creditors who vote.
Yes, if the secured creditors agree or the
court so orders.
The creditors can approve a deed that
discriminates against particular creditors, but
cannot alter employees’ priority rights.
US – Chapter 11 procedure
Good faith only.
The directors.
To avoid some contracts, avoid some past
transactions and restructure balance sheet.
Procedure initiated by petition to the court.
Continuing close court involvement in the
rehabilitation procedure, including final
approval of plan.
The directors (unless the court orders their
replacement by an independent trustee).
Major role. Can employ professional advisers at
the company’s expense.
Court-approved disclosure statement.
Automatic moratorium, which applies to all
secured and unsecured creditors.
No.
No.
Company liable as debtor in possession, with
debts having priority over pre-commencement
unsecured debts.
Company can disclaim executory contracts, with
counterparty ranking as an unsecured creditor.
Company can avoid selected classes
of transactions.
The court can give a lender a priority over all
existing unsecured creditors and, if necessary,
over existing secured creditors.
The directors, usually in consultation with
professional advisers, during the exclusivity
period (see below).
After the exclusivity period, any interested party,
including the creditors.
Typically at least 120 days.
Meetings of each class of creditors.
“Unimpaired” creditors deemed to
have approved plan.
Two-thirds in amount, and more than one-half by
number, of creditors who vote, class by class.
A dissenting class can be overridden by the
“cramdown” rules.
Yes, provided:
• if impaired class of secured creditors, at least
one impaired class assents; and
• the plan is fair and equitable.
Under the “absolute priority” rule, senior creditors
are paid before junior creditors. All creditors are
paid before shareholders. One class cannot
receive less than another class with identical
priority without the consent of its members.
Receivership
Financers typically require a debtor
company to provide security, usually a
mortgage debenture, containing a fixed
and floating charge. The debenture usually
allows the financier to appoint a receiver
to the debtor upon default under the
instrument. A receiver is appointed to
the company for the purposes of realising
company assets to discharge the debt
owing to the secured creditor. Receivers
enjoy sweeping powers under both the
debenture and statute, including the power
to take possession of the company’s
assets, realise those assets or carry
on the business of the company.
The terms of the security govern the
appointment. The secured creditor decides
the identity of the receiver and, in doing
so, is under no obligation to consult with
the debtor company. Usually the receiver
is a professional insolvency practitioner.
A receiver owes duties principally to the
secured creditor, not to the debtor or its
unsecured creditors. However, a receiver
is subject to statutory duties in exercising
his or her powers, including a duty of care
in exercising a power of sale to achieve a
market price. The receiver is also subject
to the supervision of the court and the
corporate regulator, Australian Securities
and Investments Commission (ASIC).
The appointment of a receiver offers
considerable advantages in terms
of immediate control (particularly of
commencement, which may take only
1 to 2 days), cost and flexibility. However,
it does not create a moratorium on
the initiation or commencement of
proceedings against the debtor.
In a very limited number of cases
a court is given the statutory power
to appoint a receiver.
Usually a deed of indemnity is provided
by the secured creditor to the receiver.
The timeframe required for a receivership
to be completed depends on the
complexity of the receivership and the
receiver’s ability to recover the secured
creditor’s security. A company can
concurrently be under both administration
and receivership. Creditors with a
charge over all or substantially all of
a company’s assets can choose to
appoint a receiver “over the top” of an
administrator. The receiver can then deal
with the secured assets unfettered by the
administration. Accordingly a prospective
purchaser of assets would usually deal
with the receiver, and not the administrator.
Such concurrent appointments (especially
to large companies) are common.
However, concurrent appointments
can make balance sheet restructuring
very difficult, given that the focus of
secured creditors is usually the sale
of secured assets.
Liquidation
Winding up may be initiated by court
order (winding up in insolvency) usually
upon a creditor’s petition, or by the
creditors (creditors’ voluntary winding up).
A simple creditors’ voluntary winding up
takes between 6 to 8 weeks and entails
various notices and meetings. A complex
winding up, which may involve recovery
actions being pursued through the courts,
could take considerably longer.
The liquidator winds up the company
and applies the assets to satisfy the
liabilities and distributes any surplus to the
shareholders. The directors’ powers cease
upon the appointment of the liquidator.
There is a stay on proceedings against
the company. Liquidators have extensive
forensic recovery powers, can recover
voidable transactions and bring
claims against directors.
Set out on page 24 is a table that
outlines the liquidation priority regime
for secured creditors for both fixed
and floating charge assets.
23
 LIQUIDATION PRIORITY REGIME
Realisation of fixed charge assets
(e.g. property, plant, equipment
and goodwill)
Priority waterfall
Costs of realising fixed charge assets
Secured creditor debts
Employee entitlements
Unsecured creditors
Shareholders
Recovering debts from
individuals: Bankruptcy
and sale under a
mortgage/foreclosure
An issue that frequently arises for portfolio
sales of non-performing loans concerns
the ability to enforce against individuals’
real property. The relevant timeframes
and operation of personal foreclosure
and bankruptcy laws can be relevant
to considerations.
A lender’s power of sale is heavily
regulated. Generally, a lender can enforce
its power of sale over mortgaged property
1 month after the borrower’s default. The
timeframe and procedures are lengthy and
complex and they vary from State to State.
24
Realisation of floating charge assets
(e.g. stock, work in progress and debtors)
Priority waterfall
Costs of realising floating charge assets
Employee entitlements
Secured creditor debts
Unsecured creditors
Shareholders
If a lender fails to recover all of its funds
from the sale of property, the lender
has recourse to the borrower for the
outstanding amount. This is the most
important distinction between Australian
real property mortgages and those of
the United States.
To realise this amount, the lender can use
the bankruptcy procedure. This can be
quick and effective if the borrower, anxious
to avoid bankruptcy, finds funds to pay
the outstanding amount within 21 days
(see page 25). However, the process
can take months if the bankruptcy runs
its course, especially if the borrower
contests the bankruptcy notice.
Recapitalising a distressed company
can be achieved either informally or
through a formal insolvency procedure.

Bankruptcy
BANKRUPTCY TIMEFRAME

Action
Creditor issues bankruptcy notice,
demanding payment
If person ignores notice a creditor’s
petition for bankruptcy can be made
In all cases there is an application
to court for a creditor’s petition
for bankruptcy
Court determines application (if
successful, court sequesters bankrupt’s
assets and appoints a Trustee)
Trustee notifies creditors of
the bankruptcy
Trustee’s report to creditors on likelihood
of receiving dividends
Trustee may pay dividends, interim
and final
Timeframe
First step
At least 21 days after the bankruptcy
notice
Within 7-14 days of the expiry of
the bankruptcy notice, but not more
than 6 months
Within 4 to 8 weeks of application
After 42 days of Trustee’s appointment
After 3 months of Trustee’s appointment
Usually after 3 months
of Trustee’s appointment

How much will it cost to collect?

The costs of collecting the debts can
include a wide range of costs which will
• Administration costs of the purchaser
need to be factored in to any valuation
calculation. Investors will typically factor • Tax costs which will typically need to
in any of the following costs: take into account corporate profits
tax and withholding tax on repatriating
• The cost of servicing the portfolio.
profits if the investor is offshore.
This will usually be provided by a third
Corporate profits tax is generally around
party servicing company. There are
30%, whereas interest withholding tax
a number of such organisations in
in Australia is generally around 10%
Australia, primarily set up to service the
consumer debt market, however some • Other specific costs such as legal
also have corporate capabilities costs, auction costs, commission
costs and stamp duty costs.

25
 What is the risk associated with the purchase?

There are many factors that may be taken into
account when determining the discount rate to be
applied to the net present value of the future cash
flow. One approach is to apply a formula and calculate
the weighted average cost of capital. This takes into
account such variables as the risk free rate, country
risk premium, debt to equity ratio, cost of debt
and the effective tax rate.
Any calculation however will need to be compared
to the investor’s desired internal rate of return for
distressed investments, whether they be portfolios
or single credits. A common theme that many of
the larger investors have expressed is that they are
working in a global environment and they are therefore
competing against returns in deals in Europe and
the US. If they can get similar or better returns on
deals in other markets, then it is hard to get these
past credit committees. As such most investors have
indicated they are working on internal rates of returns
in excess of 20 – 25%. For more information on
using secured convertible notes see page 34.

Sons of Gwalia risk – shareholders as unsecured creditors

The Australian High Court case of Sons of Gwalia v Margaretic (Sons of Gwalia decision) confirmed
that shareholders in publicly listed companies may prove as unsecured creditors in the administration
or liquidation of the company in respect of a successfully established claim for misleading and
deceptive conduct or non-compliance with the continuous disclosure regime by the company
prior to its insolvency. Such claims are generally founded on a company’s failure to disclose
its true financial state to the market.
The circumstances in which a shareholder will be able to establish a claim are limited, both in relation
to the factual and legal circumstances. For example, there will usually be practical difficulties in
establishing such claims, particularly in proving the elements of reliance on the alleged misleading
and deceptive conduct and causation (there is no “fraud on the market” in Australia).
While these shareholder claims may be difficult to establish, the existence of such potential claims must
be considered in valuing distressed debt since such claims may dilute the value of the unsecured debt.
Following the Sons of Gwalia decision the Australian Federal Government commissioned
the Corporations and Markets Advisory Committee (CAMAC) to examine whether the law
should be changed. CAMAC released its report on 29 January 2009.
While its members were not in complete agreement, CAMAC recommended that legislative reform
was not required to overturn the Sons of Gwalia decision or to postpone, cap or prohibit aggrieved
shareholder claims. CAMAC considered that any move to limit the rights of recourse of aggrieved
shareholders where a company is financially distressed could be seen as undermining apparent
legislative aims to provide shareholders with direct rights of action in respect of corporate misconduct.
The Australian Federal Government is considering CAMAC’s recommendations. Legislative reform
would be required to reverse or limit the effect of the Sons of Gwalia decision and it is unlikely that the
Australian Federal Government will make any decision on this issue for quite awhile. Until there is any
legislative reform, shareholders will be able to make claims against an insolvent company based on the
fact that they were misled into buying shares in the company and will be treated as unsecured creditors
in respect of those claims.
If investors acquire secured debt or invest in distressed companies using secured convertible notes,
this risk can be avoided.

26
 Perspective

• The first step is assessing the value of the distressed debt.

• Sellers of distressed debt need to be aware of the factors which determine

the value of the loan portfolio and the buyer’s key considerations. Pricing
depends on various factors including the credit approval process, the
quality of the portfolio, the type of sale, the timing of the sale, and the risks.

• Buyers will consider the type of loans, whether they are corporate or
consumer, how much of the individual debt can be recovered, whether
the debt is secured or unsecured, how long it will take to collect, how
much this will cost and the risks associated with the debt recovery process.

• Buyers need to be aware of Australian corporate insolvency procedures,

the differences between voluntary administration, receivership and
liquidation, as well as bankruptcy procedures for individuals. The key
steps, timeframes, costs of each process, as well as the extent of power
to administer and conduct a company’s business are crucial considerations.

• Assessing the risks associated with the purchase is a major consideration.

To determine the discount rate to be applied to the net present value of
future cash flow, one approach is to calculate the weighted average cost
of capital taking into account variables such as risk free rate, country risk
premium, debt to equity ratio, cost of debt and the effective tax rate.

• In valuing distressed debt of a company, buyers also need to be aware of

the effect of the Australian High Court case of Sons of Gwalia v Margaretic,
discussed on page 26.

Large foreign investors have

indicated they are working
on internal rates of returns
in excess of 20 – 25%.

27
 3. Using secured debt
to control outcomes
and obtain ownership
of the assets
A secured creditor who is entitled to enforce a charge over the
whole, or substantially the whole of a company’s property has
wide powers of enforcement especially in relation to companies
that may also be in administration. Such a secured creditor
can elect to appoint a receiver over the secured property
even during the first 13 days of an administration.

Thus, a secured creditor can opt out
of the voluntary administration process
and enforce its security. If the secured
creditor fails to take this step within the
13 days it will be unable to enforce its
security during the period of the voluntary
administration; however a practice has
developed whereby administrators extend
this period in order to encourage secured
creditors to support their appointment.
In the case of a secured creditor whose
entitlement does not extend to the whole
or substantially the whole of the company’s
property, then that secured creditor will
be unable to appoint a receiver without
the administrator’s or the court’s consent.
In these circumstances, the secured
creditor becomes subject to the actions
of the voluntary administrator during the
course of the administration. An exception
to this rule arises if the secured creditor
takes steps to enforce its charge before
the appointment of an administrator.
This enforcement power may, however,
be restricted by the court on an
application by the administrator.

28
A receiver exercising a financier’s power
of sale over secured property must take
reasonable care to sell the property
at no less than its market value.
Voting ability
In a receivership, the receiver realises
assets for the benefit of the secured
creditor and there is no process for
unsecured creditors to vote. Therefore
unsecured creditors have limited formal
input into or influence over a receivership.
In a voluntary administration, the future
of the company is decided by a vote of
creditors. Resolutions are passed by a
majority in number and value. If there
is a deadlock, the chairman of the
meeting (the administrator) has a casting
vote. The casting vote may (but will
not always) be exercised in accordance
with the vote of the majority of the value
of the creditor pool. Thus, a party that
controls more than 50% of the liabilities
of a company in administration, both
in value and number, may have control
of the outcome of voting and thereby
control the company’s destiny. Employees
typically form the majority of creditors in
number and thus are an influential voting
block. Secured creditors can vote in full
without valuing their security.
Duties affecting the power
of sale – section 420A
A receiver exercising a financier’s power
of sale over secured property must take
reasonable care to sell the property at
no less than its market value, or if no
market value can be ascertained, at the
best price available in the circumstances.
This duty arises under section 420A of
the Corporations Act 2001 (Cth). A similar
duty arises under common law.
These duties of care aim to ensure that
receivers do not sell assets at a discount
simply to recover secured debt quickly
and cheaply at the expense of both the
secured creditor and other creditors.
Generally, in order to fulfil these obligations
a receiver will pursue a structured and
public sales process, including:
• advertising the assets and requesting
expressions of interest
• undertaking due diligence
• organising tender bids
• deciding on preferred bidder
• selling to preferred bidder.
There is no equivalent to section 420A
for voluntary administrators, however,
the administrator has a duty to act in
the best interests of creditors and this
includes realising market value for assets
sold. In certain circumstances it may be
necessary to sell a business very quickly
during an administration to preserve
goodwill and avoid the termination of
contracts. While an administrator in selling
assets does not need formal creditors'
approval, usually creditors' views are
considered before a sale is effected.
29
 Pre-pack appointments
A “pre-pack” appointment occurs in There have been few pre-pack
a receivership or an administration when administrations and receiverships to date
the sale of an insolvent company, or its in Australia. This is due to the difficulties of
assets, is negotiated by stakeholders managing stakeholders and the concerns
(including creditors, shareholders, key about the duty of the administrator or
customers and key trade suppliers) receiver in the sales processes. Although
and agreed before the formal this concern is legitimate, the pre-pack
procedure is commenced. sales exist to maximise the value of the
business and its assets and avoid the
The key advantage of a pre-pack is to
loss of goodwill often associated with
maximise the chances of a rescue for
unplanned insolvencies.
the company while it remains a going
concern without the loss of goodwill
usually associated with an unplanned Control strategies
insolvency announcement. Pre-packs
are commonly used on companies with A party looking to invest in a distressed
contract or service based businesses. company or its assets will often seek to
acquire secured debt in the company as
The process begins with negotiating the a first step to gain control and then drive
pre-pack arrangement. Once agreement through a sale or recapitalisation.
is reached, an administrator (or receiver)
is appointed, and the pre-ordained sale
of the company or its assets is executed
expeditiously. Because the pre-pack
sale occurs without the business or
its assets being offered on the open
market, the sale could be impugned as a
breach of the administrator’s or receiver’s
duty of care in selling the company or
assets (discussed above). To avoid this,
administrators are required to show
that due enquiries were made regarding
the real value of the asset or business
during the pre-pack process before the
administration, and that the sale continues
to be reasonable and in the best interests
of creditors after administration begins.

30
 Perspective

• An important consideration for buyers when assessing a distressed asset is

to assess how much debt is secured because secured debt can be used to
control outcomes and obtain ownership of assets.

• A secured creditor who is entitled to enforce a charge over the whole,

or substantially the whole, of a company’s property has wide powers
of enforcement especially in relation to companies which may also be
in administration.

• A control strategy for buyers is to acquire the secured debt and

drive through the sale or recapitalisation.

• Buyers need to be aware of the duties placed on a receiver by the

Corporations Act 2001 and common law when exercising a financier’s power
of sale over secured property to take reasonable care to sell the property
at no less than its market value, or the best price in the circumstances.

• If a buyer’s strategy is to preserve value in a distressed company such as a

contract or service based business, one strategy is to enter into a “pre-pack”
arrangement, to maximise the value of the business and its assets and avoid
loss of goodwill, associated with unplanned insolvencies.

A party looking to invest in a distressed

company or its assets will often seek to
acquire secured debt in the company as
a first step to gain control and then drive
through a sale or recapitalisation.

31
 4. Recapitalising distressed
listed/unlisted companies
In some cases, recapitalising a distressed company can
have significant advantages over an asset sale.
These advantages include:
• Tax advantages – Asset sales can attract
significant stamp duty (although stamp
duties on business assets other than
land are progressively being phased
out in Australia)
• Investors can retain company
specific benefits such as the existing
infrastructure of a company’s operations,
including contracts and employees.
Recapitalising a distressed company can
be achieved either informally or through a
formal insolvency procedure. A distressed,
though solvent, company and its
lenders may decide that the company
can return to health despite its current
difficulties with debt.
Privately-held companies can be
recapitalised with relative ease. With
supportive lenders and shareholders,
substantial new equity can be injected
quickly and with minimal publicity.
It may even be possible to recapitalise
a distressed company without the
support of its existing shareholders.
Publicly listed companies face more
complex challenges, although it is equally
possible to recapitalise a distressed
listed company quickly.
32
The ASX Listing Rules generally limit the
amount of equity that can be placed
to an investor without shareholder
approval to 15% in any 12-month period.
Australian takeover laws prevent an
investor from subscribing more than
20% of voting shares in a company
without shareholder approval. A significant
feature of shareholder approvals of this
nature is that an expert’s report as to the
proposal’s fairness and reasonableness
is generally required, adding to the
cost and complexity of the proposal.
Obtaining shareholder approval (and
an expert’s report if one is required)
can result in considerable delay in the
distressed company getting access to new
funds, which it may not be able to afford.
However, there are various exceptions
to the shareholder approval requirement
that can be used to facilitate a
recapitalisation quickly. In particular,
exceptions to both the 15% Listing
Rule limit and the 20% takeovers law
restriction are available for pro-rata rights
issues (including underwritten rights
issues) to shareholders. In addition,
waivers from the general 15% rule can
be sought from ASX to facilitate rights
issues on an “accelerated” basis, which
combine advantages to the company
of an accelerated institutional offer (quick
access to funds) with the advantages
to retail shareholders of a rights issue
(minimising dilution through participation
in the recapitalisation).
Recent reforms to the voluntary
administration regime certainly
encourage recapitalisations.
Raising equity is now much easier.
By way of example, suppose an investor
wishes to participate in a recapitalisation
of a listed company in desperate need
of funds. The company could make a
placement to the investor of up to 15%
of the company’s capital. The company
could then announce an accelerated
rights issue, underwritten by the investor.
Properly structured, the proposal would
enable the company to access the funds
from the placement and the institutional
component of the rights issue almost
immediately, and enable the investor to
acquire a significant stake in the company
through the placement and by taking up
its entitlements and any shortfall under the
rights issue without the timing constraints,
cost and uncertainty associated with
seeking shareholder approval for the
recapitalisation proposal.
In general, the techniques available to
listed companies are also available to
managed investment schemes, such
as real estate investment trusts and
infrastructure vehicles, although additional
considerations arise due to their unique
structure. In particular, amendments
to the entity’s constitution may be
required to facilitate a recapitalisation.
Listed companies are also subject to
continuous disclosure obligations under
the Corporations Act and the ASX Listing
Rules, which in broad terms require them
to immediately disclose information that
would be expected to have a material
effect on price or value to the market as
soon as the company becomes aware
of that information.
Any recapitalisation proposal will become
public as soon as it is agreed (or perhaps
even during negotiation). This can
increase the likelihood of a competing
proposal emerging, thereby placing the
investor’s proposal at risk, particularly
where the proposal remains conditional
on announcement (for example, it is
conditional on shareholder approval).
To manage this risk, investors should
agree appropriate deal protection
measures such as break fees and
arrangements restricting the company
from negotiating competing offers.
Recent reforms to the voluntary
administration regime certainly encourage
recapitalisations. Raising equity is now
much easier. Administrators have a
specific power to transfer shares with
the court’s or shareholders’ permission,
whereas previously, administrators had
no right to do so without shareholder
consent. Additionally, administrators can
be exempted from the detailed and costly
disclosure obligations associated with
issuing new equity where this is issued in
exchange for debt. It is also now possible
to change a company’s name without
shareholders’ consent. This is a significant
advantage where changing the name
might ease a sale, for example, a potential
buyer might want to apply its own brand
to the company. Similarly, the administrator
can now apply to the court for permission
for the company to operate without
setting out the words “Subject to Deed
of Company Arrangement” with its name in
advertising or documents. This benefit can
be significant where those ominous words
might alienate customers or suppliers.
33
 Secured convertible notes
Secured convertible notes offer investors
a way to combine potential equity upside
and control, while protecting themselves
against the risk of having to compete
against a multitude of unanticipated claims
if the recapitalisation should fail. In light
of the decision in Sons of Gwalia, which
allows shareholders who believe they
have been misled into buying shares in
a company to make a claim against an
insolvent company and be treated as an
unsecured creditor, secured convertible
notes have become an increasingly
important instrument for investors
in distressed entities. For a detailed
discussion of Sons of Gwalia see page 26.
Liability management
through deeds of
company arrangement/
schemes of arrangement
The voluntary administration regime in
Australia provides a way for companies
in financial distress to be reorganised.
A deed of company arrangement is
a mechanism incorporated within
the voluntary administration regime
and allows a company to enter into
compromise arrangements with its
creditors to avoid going into liquidation.
The law provides for extensive flexibility
when dealing with a deed of company
arrangement so the deed can be drafted
to meet the particular circumstances
of the company and its creditors. The
passing of a resolution to implement a
deed binds all of the company’s unsecured
34
creditors irrespective of whether or not
they voted in favour of the resolution.
Conversely, only those secured creditors,
lessors of property and owners that voted
in favour of the resolution of a deed will
be bound by it.
The liabilities management of the
insolvent company is enhanced by a
deed of company arrangement because,
depending upon the terms of the deed,
all or some of the company’s pre-existing
debts and claims may be extinguished
after the deed obligations are met.
Having creditors reduce the size of their
claims enhances a company’s ability to
recommence trading. Unsecured creditors
agree to a reduced return on the basis that
they will receive a greater return from a
deed of company arrangement than they
would if the company went into liquidation.
Creditors may also contemplate receiving
increased returns from the future trading of
the company operating under a deed.
Deeds of company arrangement
have been traditionally used to
restructure a company’s debt capital,
but are now increasingly being used
to effect a whole of balance sheet
(including equity) restructuring.
A scheme of arrangement is an alternative
way for a company to come to a financial
agreement with its members and creditors.
The liability management advantages of
a deed of company arrangement can
also be achieved through schemes of
arrangement. Schemes of arrangement
can be useful to manage class action risk.
 Perspective

• A buyer needs to consider whether revitalising a distressed company

may have advantages over a sale of assets. Advantages include
avoiding stamp duty on asset sales and retaining company specific
benefits such as the legal infrastructure of the company’s operations,
for example contracts and employees.

• Key considerations for this strategy include whether the company

is still solvent, and whether it is a private or publicly listed company.

• Revitalising a listed company can be complex, because of ASX Listing

Rules and Corporations Act regulatory requirements. The public
disclosure requirements also mean that any recapitalisation proposal
can become public and deal protection measures need to be put
in place to manage the risk of competing proposals.

• Restructuring a company’s debt capital or to effect a whole of

balance sheet restructuring can also be managed through deeds
of company arrangement or schemes of arrangement.

• The taxation consequences of conducting a business in Australia

need to be considered.

35
 5. Why should an Australian
bank sell debt?

Historically Australian banks have not participated in the

debt sales market other than on some large deals such
as the Sons of Gwalia administration in 2003/04 and sales
of past due credit card debts on a forward flow basis.

The reason given for this general level of inactivity is simply BAD DEBT EXPENSES
that they have not had to. Until recently, the Australian (AVERAGE ACROSS ANZ, CBA, NAB AND WBC)
economy had been on an unbroken growth trajectory
since the early 1990s. Levels of defaults and hence non- 2.0%

performing loans on banks’ balance sheets have been

1.5%
BDE % of Assets

low, as highlighted in the chart, Bad Debt Expenses.

However all this may soon change.
1.0%
As highlighted in the chart, Bad Debt Expenses, the
level of bad debt expenses for the 4 Big Banks began 0.5%

to rise significantly in 2008 and are forecast to increase

0.0%
further in 2009 and 2010. Significantly, in dollar terms
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
bad debt expenses have increased from A$2.2 billion
in 1997 to A$6.3 billion in 2008 and forecast to increase Source: Company reports and ABN AMRO
to A$14.3 billion in 2010.
Why is this period of increased impairments likely to
differ from the early 1990s in terms of Australian banks’
attitudes to debt sales? There are several reasons:
DISTRESS DEBT AND SPECIAL
• Increased number of buyers SITUATIONS FUNDRAISING
2000-2007
The distressed debt market has expanded significantly
in Asia since the Asian banking crisis in the late 1990s.
30
The number of funds and amount of capital dedicated
25
to this sector has increased considerably, with the 2007
20
year on track to be a record for raisings as highlighted
15
by the graph on the right.
10
5
• Management time and focus on workout
0
Workouts are time consuming, generally complex and can 2000 2001 2002 2003 2004 2005 2006 AUG YTD
2007
be costly. As one Australian banker indicated, lending to
No. of Funds Aggregated Commitments (US$B)
distressed entities is “credit intensive”. In times when there
are so many workout opportunities for banks, the ability to Source: Preqin – Special Research Report: Distressed Debt and Special Situations Aug 07
manage them with limited or scarce resources becomes
an issue. This scarcity of resources is exacerbated by the
strong economic growth over the last 15 years, which
means that sourcing enough skilled staff with good
workout experience has become problematic.

36
 This is the first year in which the full
implications of Basel II will be felt
and there is a real concern that banks
and regulators have not appreciated
the full impact of Basel II as levels
of NPLs increase significantly.
• Basel II implications of carrying NPLs
The major change from the early 1990s
has been the introduction of Basel II.
This is the first year in which the full
implications of Basel II will be felt and
there is a real concern that banks
and regulators have not appreciated
the full impact of Basel II as levels of
NPLs increase significantly. In essence,
banks now have to set aside Tier 1
capital to cover the possibility of losses
against loans. In the case of NPLs the
percentage of Tier 1 capital required
can be 20% to 25% of the gross loan
value. Therefore if a bank in Australia
has a A$100 million loan to a customer
who has defaulted on repayments, then
where the bank has made a provision
of 45% against the loan, it may be
required to set aside up to A$23 million
in Tier 1 capital (essentially cash or other
similarly liquid securities). The levels of
specific or general provisions held against
loans are not taken into account when
determining the required level of capital
under the Advanced Basel II rules. So in
the above example the sale of the loan
would free up A$23 million in cash to be
otherwise applied to generating income
for the bank.
From an opportunity cost perspective,
A$23 million in Tier 1 capital could
support A$460 million of performing
corporate loans. This would equate to
approximately A$37 million of interest
per annum at an 8% interest rate.
• Liquidity constraints brought
on by the global financial crisis
Access to liquidity has become a very
real concern for all businesses including
banks. The issue of liquidity for banks
is twofold, firstly to have funds available
to lend in to the Australian economy.
Secondly, in line with the point above,
banks are required to maintain minimum
capital adequacy ratios. While Australian
banks are not likely to fall below the
minimum levels set by the Australian
regulators, the banks’ cost of funding
could well increase if their capital ratios
fall below acceptable thresholds.
As a result many Australian banks have
recently raised capital to improve their
Tier 1 capital adequacy ratio. At some
point however, a tipping point will be
reached when it is no longer efficient from
a shareholder return perspective to raise
further capital. At this point therefore
the bank will need to weigh up if debt
sales represent a more efficient way to
manage the level of Tier 1 capital required.
There is a number of other considerations
that may need to be taken in to account by
a bank when considering selling its NPLs.
These may include:
• Realising a tax benefit from writing
off a NPL
Under Australian tax law Australian banks
cannot realise a benefit from a NPL
until it is fully written off or the bank has
recovered the net loan proceeds and
crystallised the loss. Therefore, when
banks take general or specific provisions
against loans their accounting profit is
reduced, however they continue to pay
tax on the profit before these provisions.
It is only when the loss is crystallised that
the banks get the tax benefit.
• Opportunity cost of redeploying
capital tied up in a NPL
For the period of a workout or recovery
the bank has the net loan proceeds
effectively tied up and not earning any
revenue. If the debt were to be sold
the funds could then be on lent to
other borrowers that are generating
the bank’s required rate of return.
37
 • Managing the bank’s reputation The graph below is an example of the
or brand in the market above description from an economic
One of the key assets of each point of view. In summary if a bank has
Australian bank is its brand. a A$100 million loan impaired by 45%
Brand recognition and awareness are then from an economic point of view
generally very high. Therefore anything if the loan can be sold for anything greater
that may potentially damage the brand than A$32 million, the bank comes out
should be avoided. Brand damage is ahead. However the example does not
likely to come from two main sources, take in account indirect costs such as
with the first centred on the bank’s management costs, reputation costs or
financial health. Growing levels of the opportunity costs associated with
provisions or NPLs may contribute the interest earned from applying the
to a general level of unease as to a Tier 1 capital to performing loans.
bank’s overall financial security. The The example below assumes an
second source is from association 8% interest rate on performing loans,
with loan foreclosure. There have been 11% cost of capital, a 3 year recovery/
a number of high profile administrations workout period of the loan and an
where the banks have had their annual tax rate of 30%.
names linked to company closures.

WHAT IS THE ECONOMIC COST OF CARRYING A NPL?

120
100
80 -45.0
$m

-11.3
60 -2.8
100 -8.5
40
55
20 32
0
Cost of deferring

(if debt sale is deferred)

Specific Provision (Financial

Net Loan Value (if debt is

Cost of deferring

on capital reqd)
reporting provision)

the tax benefit

sold immediately)

Cost of Capital (interest cost

Loan value

the recovery

Net Loan Value

Source: PricewaterhouseCoopers

38
 Perspective

The main reasons for Australian banks to consider selling debt are:

• Increased number of buyers

• Increased costs and complexity of managing workouts in-house

• Basel II implications of carrying NPLs – setting aside Tier 1 capital

to cover the possibility of losses against loans

• Improving liquidity position

• Realising a tax benefit from writing off a NPL

• Redeploying capital tied up in a NPL

• Managing the bank’s reputation or brand in the market

• Managing market perception.

In dollar terms bad debt expenses have

increased from $2.2 billion in 1997 to
$6.3 billion in 2008 and are forecast
to increase to $14.3 billion in 2010.

39
 6. How does a
non-performing loan
portfolio sale work?

For the sale of a portfolio of NPLs to be viable,

financial institutions will need to examine their objectives,
understand the nature of the product they are selling,
and become familiar with the way the market operates.

Determining what to sell, the method of
sale, the information about the portfolio
and how to present it are all key aspects
that need to be considered to ensure that
the seller maximises return. Establishing
the key driver for the sale at the beginning
of the process is a crucial step.
Financial institutions principally have two
options for dealing with NPLs – internal
or external workout, as illustrated below.

Options for dealing with NPLs

Internal workout External workout

Loans remain on Workout by in-house Outsourcing of the

the balance sheet collection department servicing/workout

Sale; and continued

Sale; and takeover
servicing of the
Loans leave the of servicing/workout
commitment on
balance sheet by an external
the basis of a
service provider
service agreement

The outsourcing of NPLs to an external
servicer still involves the continued
involvement of the bank in monitoring
and overseeing portfolio management,
which in turn diverts time and focus
from more profitable banking activities.
An outright sale removes NPLs from
the bank’s balance sheet, favourably
impacting the bank’s overall NPL levels
and capital adequacy, and may allow the
bank to redeploy staff resources to less
time consuming, higher return customers
in the early stages of delinquency.
Aside from the above general benefits,
banks that intend to conduct a NPL sale
will often have an overriding objective
for the sale (such as timing or profit
generation) and this will determine
the size and composition of the NPL
portfolio to be taken to market and
the sale process.

40
Determining what to sell, the method of
sale, the information about the portfolio
and how to present it are all key aspects
that need to be considered to ensure
that the seller maximises return.
BENEFITS OF DISTRESSED ASSET SALES RELATIVE TO BANK OBJECTIVES
Bank objectives
• Improved liquidity position of the
institution, freeing up funds for
new lending and investment
• Better capital & debt market
perception, thus reducing funding
costs and raising share price
• Improved ratings (S&P, Moody’s),
again reducing funding costs and
raising share price
• Improved capital adequacy position
– particularly in light of Basel II
requirements for weighting on NPLs
• Immediate and future positive impact
on profit and loss via possible
provision write backs, utilisation of tax
assets, accelerated recoveries and
savings on human resources costs
• Overcome an inability to manage
problem loans in-house effectively
• Freeing up management time and
focus resources on more profitable
activities/collections
• Release/redeploy staff resources,
thus improving cost to income ratios
Asset class Reason
Secured corporate • Sale of secured loans is likely to
generate higher values.
Secured consumer
• Reducing the balance sheet doubtful
Real estate
debt provision and improving
owned assets
capital adequacy ratios is generally
viewed favourably by capital and
debt markets and rating agencies.
However this may need to be traded
off against the potential profit and loss
(P&L) impact caused by the differing
valuation methodologies used by
sellers and buyers.
• Basel II requires Tier 1 capital
requirements to be based on the
gross value of loans rather than the
net value hence selling higher gross
value NPLs will have a greater impact
on capital adequacy calculations.
Unsecured corporate • Generally limited or no underlying
collateral and therefore larger
Unsecured retail
provisions can be raised against
Delinquent these debts making it easier to
receivables portfolios result in a profit on sale.
(telco and utility
• Substantial number of customers/
debts, store cards,
loans with relatively low average
etc.)
balances outstanding. Requires
a similar amount of contact
and monitoring as a secured
debt but generally has a lower
yield. A reasonable size portfolio
(approximately A$300 million)
could remove up to 60,000 loans
41
 DETERMINATION OF THE SALE STRUCTURE
The determination of the sale structure is also fundamental to the sale process and often
involves consideration of the following three strategies:

1. Private placement

• deal structuring • no competition; price reduced

• speed of sale
• information supplied specifically
tailored to investor
• confidentiality easier to maintain
• may not reach highest
potential bidders
• limited widening of general
investor base
• less certainty for investors

2. Auction (limited or open public)

• reasonably quick process • information needs are wide

but remain controllable
• price maximised
• will not reach all potential investors
• wide base of professional
investors reached • process requires more management
• one-off process

3. Securitisation

• reaches widest potential investor base • requires rating; extensive

information requirements
• maximum profile
• ongoing management required
• debtor relationship retained
• higher initial costs
• issues can be “topped up”
with later portfolios • subject to current market uncertainty

42
SALE PROCESS
Notwithstanding the sale type, the sale process often involves the following four work phases, with each phase
being interconnected:
Phase 1
Phase 2
Project Portfolio
Strategy
Planning Identification
Development
& Valuation
Confirm your overall Portfolio identification Develop overall
goals and objectives and classification sale strategy
Finalise Due diligence
work program review and validation
Valuation
Project Management
The three sale processes on page 42
should not be considered mutually
exclusive. One strategy may apply to
the whole portfolio or to different pools
or each of the three strategies could be
applied to different asset pools depending
on an assessment of how value will
be maximised and the seller’s exact
priorities. For example, if maximising
the net proceeds is paramount, then
an auction or securitisation process
would be preferable. If speed of sale or
confidentiality of information is paramount,
then a private placement is likely to provide
the quickest exit route.
Given the recent increase in the supply
of NPLs in the global market created
by the recent global financial crisis,
coupled with competition for investor
resources, the NPL market appears to
have moved from what was considered
a “seller’s” market pre 2007 to a more
“buyer” centric market. This may impact
the sale structures going forward as
generally buyers will show a preference
for bilateral deals.
Distressed asset loan portfolios have
become an established asset class
for many international distressed debt
investors. The major distressed debt
investors have developed unique skills
and expertise in buying and working
out NPL portfolios throughout the
US, Asia and Europe and can often
negotiate deals with borrowers that
Phase 3
Phase 4
Sale
Execution
Preparation
Development of bid Investor and
documents and SPA sale management
Establish due
Negotiation
diligence and data
support
room procedures
Marketing of the
Closing
sale transaction
are unfeasible for the originator due to
political or market perception reasons.
Unlike banks, unlocking value in NPLs is
the core business of a distressed debt
investor and they use proven collection
methodologies in order to achieve this.
For this reason such investors are willing
to pay competitive prices to gain access
to such assets/markets.
To diversify their exposures, distressed
debt investors are beginning to look
outside the traditional and established NPL
markets. However, these investors have
come to expect sale processes and legal
documents to be reasonably consistent
from country to country. Combine this
expectation with the fact that one of
the key determinants of value for an
investor is the speed with which they
can start “working” the portfolio and it is
clear that the information prepared and
presented to investors as part of the due
diligence process is critical to the success
of any sale.
Investors have very specific information
requirements when bidding for distressed
assets and some of this information can
take time to collect. Contacting investors
and commencing a sale process without
the required information will most probably
result in a long drawn out sale process,
which in turn will both increase the cost
of participating in the sale and decrease
the overall value of the portfolio.
43
 To maximise value for investors and, ultimately through
higher prices provide more value for the bank, it is
considered market best practice to consider the
following (in conjunction with appointing a qualified
sell-side advisor):
• Consistent sales process – Investors are looking
for a professional sales process and confidence that
the seller will proceed with the transaction closing
at a realistic market-based price.
• Quality and timely information – Investors
require quality information to minimise additional
risk discounting and maximise value. Key
information includes historical data, virtual data
rooms, representative sample information of
scanned documentation, updated real estate
appraisals for collateralised assets, past
collection policies, repayment plans, recent
borrower correspondence, financial information
on large corporate borrowers, and standardised
market-based legal sale documentation.
• Simple sale process – From an investor’s
perspective the less complex the sale process the
better. A process with too many bid stages or that is
unstructured can be time consuming and confusing
for investors. It can also make it difficult for the seller
to compare bids at the end of the process.
• Reliable and realistic sale timetable – A timetable
that is adhered to by the bank and investors
limits the resource commitment from the bank
and the investor.
A key area of concern for sellers of debt revolves
around the confidentiality of the borrower’s
information. The ability of a lender to trade a
borrower’s debt in circumstances where they
have confidential information may be restricted
by obligations of confidence and insider trading
laws. It may also be impacted if the lender has
a representative on a creditors’ committee.
Lenders will typically be provided with access to
financial and other sensitive information about a
borrower which is subject to express or implied
obligations to keep the information confidential or
to use it only for certain specific purposes (such as
monitoring performance of the company). The lender
may breach its duty of confidentiality to the borrower
if it discloses information to a prospective buyer
of the debt without the borrower’s consent.
44
Confidential information received from a borrower or
information about the status of the debt (e.g. potential
default or a proposed restructure of the terms) may
be price sensitive and therefore “inside information”
for the purpose of the insider trading laws. If the debt
is a financial product to which the insider trading laws
apply (e.g. notes, bonds or debentures issued by the
borrower) possession of inside information prevents
the lender from dealing in the debt until the inside
information becomes generally available or ceases
to be price sensitive.
Some strategies to limit the risk of liability include
the use of “Chinese walls” to manage receipt of
confidential information and to ensure the lender’s
flexibility in trading the debt, and only trading under
information symmetry between counterparties, such
as between other creditor committee members or
other investors with the same degree of knowledge.
Lenders can also include specific provisions in
their lending documentation to facilitate distressed
debt trades. This may extend to a requirement
that the borrower confirms the accuracy and
currency of financial information if the lender
intends a debt transfer.
In addition, publicly listed borrowers are subject to
continuous disclosure obligations, which in broad
terms require them to immediately disclose information
that would be expected to have a material effect
on price or value to ASX as soon as the company
becomes aware of that information.
In its Companies Update 02/08 issued last year,
ASX made it clear that listed entities that have
in place (or have put in place or altered) material
financing arrangements which contain covenants
that may be triggered on certain events occurring,
may need to disclose details of the arrangements
at the time the covenants are (or are likely to
be) activated. Disclosure may need to include
details of the covenants in question, as well as
other information such as any impact that the
triggering of the covenant may have on the entity’s
relationship with its bankers, its financial position
and its financial performance (to the extent that
information is material). In practice, market disclosure
of this nature may overcome the lender’s inability
to deal with the debt by reason of confidentiality
constraints or possessing “inside information”.
 Perspective

• As a seller, a bank or financial institution needs to make sure the sale

of a portfolio of NPLs is viable, by examining their business objectives,
understanding the nature of the product, and becoming familiar
with buyers’ needs and the way the market operates.

• Sellers need to determine their sale strategies, including whether

to sell by private placement, auction (limited or open to the public)
or by securitisation, depending on their objectives.

• To ensure successful sales banks need to be aware that the buyers

are sophisticated and have expectations of consistent sale processes
and legal documentation, quality and timely information, and a reliable
and realistic sale timetable.

• A seller also needs to be careful not to breach its duty of confidentiality

to the borrower and put strategies in place to limit the risk of liability
for the purpose of insider trading laws.

Given the recent increase in the supply

of NPLs in the global market, the NPL
market appears to have moved from
a “sellers” market pre 2007 to a more
“buyer” centric market.

45
 7. Structuring options for
sellers of debt/assets

In the current economic climate the biggest obstacle

to getting a deal closed is the difference between the
bid price and the asking price for any deal.

From the buyers’ view the sellers have not adjusted their price expectations given the
state of the economy, and from the sellers’ perspective the buyers are over emphasising
the risk. One potential step to try and bridge the gap between the bid and asking prices
is to structure a deal that shares risk and rewards. From single credits to portfolios,
returns may be improved by considering various alternative structures.
Any intended structure will need to take into consideration the seller’s objective
for the debt sale.
Typically most sellers of debt, especially financial institutions, are motivated by
both the quantitative and qualitative benefits of selling problem loans:
Depending on the goals of the seller, and the regulatory environment in which the
seller operates, typically three types of sales structures are considered to maximise
the seller’s objectives, as outlined below.

SELLING LOANS

Quantitative benefits Qualitative benefits

• Immediate reduction of NPLs in a timely • Free up resources of recovery teams

manner – improve NPL position
• Possible gain on disposal for the NPLs
(depending on provision levels)
• Improve liquidity position of the bank
and capital adequacy position –
possible release of capital and resources
which can be used for other purposes
• Reduction in other holding costs
relating to NPLs – e.g. ongoing legal fees,
payment of maintenance on collateral
• Minimise and/or better manage future
provisioning requirements
– account officers can be re-assigned
to other areas in the bank
• Recovery teams can focus on remaining
NPLs that have a better chance of
recovery and maximise recovery potential
• Speed up timing of recoveries as a
large number of NPL loans can be sold
at one time via a portfolio sale
• Positive market perception –
proactive management of NPLs
may lead to improved ratings

46
SALES STRUCTURES MAXIMISING SELLER’S OBJECTIVES
OPTION 1: OUTRIGHT SALE –
TYPICALLY FOR CASH
Buyer
[Investor]
NPL
Cash
Equity SPV
Option 1: Outright sale
– typically for cash
The first option involves the outright sale
of the debt. Most buyers of debt in this
scenario will establish an on-shore entity
or special purpose vehicle (SPV) in which
to warehouse the transaction. In fact,
many jurisdictions in Asia require an entity
which meets local regulatory requirements,
typically local majority ownership, to be
established for these types of transactions.
In this instance, all economic interest in the
credit/portfolio would pass to the SPV and
its ultimate owners. The selling bank would
not retain any interest in the credit/portfolio
although in some instances the selling
bank may be contracted to continue
servicing the credit or portfolio.
At present, this is generally the preferred
option of most selling banks in Asia,
particularly for portfolios, as it achieves
the following aims:
• A reasonably quick process
• Immediate release of resources
• Immediate de-recognition from
the balance sheet
• Perceived to be transparent transaction.
Investors are also generally in favour of
this structure as it provides complete
control over the transaction and allows
for a relatively free hand in structuring
the ownership of the SPV.
Option 2: JV arrangement
The second option involves forming a joint
venture (JV) between the selling bank and
the buyer. In this scenario the selling bank
typically holds an equity stake in the SPV
OPTION 2: JV ARRANGEMENT
Debt Seller Buyer Debt Seller
[Bank] [Investor] [Bank]
NPL
Cash Cash Cash
Equity SPV Equity
alongside the buyer. Under this option, the
SPV would acquire the credit/portfolio from
the bank for a combination of cash (from
the buyer) and non-cash “contribution”
(the NPLs) from the bank. The economic
interest in the portfolio would then be
shared by the equity holders pro rata to
their equity stakes or another method
(e.g. profit sharing) as agreed between the
parties.
Generally the main reason for choosing this
option is price, especially if a value cannot
be determined or the value depends upon
some future event. JV arrangements
are often adopted for real estate finance
projects or where there may be some
perceived sensitivity in relation to the
portfolio, for example the bank wishes
to remain involved and minimise any
negative publicity that may result in the
event of an outright sale. Alternatively it
is also a mechanism to give the bank the
ability to increase its return if actual returns
are greater than a buyer’s expectations.
The form of the JV arrangement is at the
absolute discretion of the parties involved
but typically sees certain buyer costs and
return requirements being met in priority to
any return back to the selling bank. Other
advantages of a JV arrangement include:
• Ability to engage expert asset managers
to maximise value (whether these
are provided by the bank or the
third party buyer)
47
 SALES STRUCTURES MAXIMISING SELLER’S OBJECTIVES
OPTION 3: SECURITISATION
Investor
servicing
Trustee
Asset
transfer
Servicer
(could be selling bank)
• Ability to retain the seller's knowledge,
i.e. the people who have been
managing the portfolio typically
remain involved and transfer
their knowledge to the buyer
• Flexibility in the deal structuring options
• Potential higher returns to the
selling bank (although these
are not guaranteed).
The main downside of a JV arrangement
is that it may not achieve derecognition
of the loans in the seller’s books, which
is often a key driver of the sale.
Option 3: Securitisation
Securitisation is the process by which
assets with generally predictable cash
flow and similar features are packaged
into interest-bearing securities with
marketable investment characteristics.
The key to securitisation is the
predictability of cashflows and supporting
loan documentation, and history to
verify these cashflows.
Unlike other bulk sales, the focus of the
investor group in this instance is usually
on the rating of the special purpose
vehicle and the coupon payable.
Loans that typically lend themselves
to securitisation include:
• Loans with dependable cashflow
streams (e.g. performing loans,
particularly mortgage/housing loans)
• Real estate portfolios with
clear cashflow streams
48
Investors
Cash
SPV
Cash
Selling bank
• Loans where loan documentation
is complete and in electronic form
allowing easier verification.
Advantages of securitisation include new
sources of funds for the seller and possible
enhancement of the selling bank’s ratios.
However the information needs are high
as underwriting costs can be significant
and transactions can be time consuming.
Other structuring considerations
While the above description primarily
focuses on sale structures that are typically
adopted by selling banks, all buyers should
consider the following during their own
structuring planning for any acquisition:
• Flexibility to accommodate current
and future business objectives (i.e. an
investment platform that allows for
various types of investments and,
if necessary can accommodate
several joint venture partners)
• Ability to enable a tax efficient exit
• Minimise any potential permanent
establishment risk, if desired, for the
investment vehicle in the local country
where the investments are made
• Analysis of tax efficient structuring for
any management company activities in
foreign jurisdictions (i.e. representative
office or branch)
• Minimise withholding tax costs
and capital gains taxes.
 Perspective

• When choosing structuring options, sellers need to ensure that their

business objectives are facilitated. Transactions involve complex
judgements about business needs, tax and accounting rules,
corporate structures and a variety of legal issues.

• Three types of sales structures which can maximise the seller’s

objectives are: outright sale – typically for cash; a joint venture
agreement; or a securitisation.

• Buyers also need to consider issues such as the structure of their

investment vehicle and the regulatory and tax considerations
of conducting the business in Australia.

• Negotiating and agreeing on the price is the key to closing the

deal in today’s economic climate. One potential step to try and
bridge the gap between the bid and asking prices is to structure
a deal that shares risk and rewards. This may mean considering
alternative innovative structures.

A structured deal has the ability

to bridge the pricing differential
between buyers and sellers.

Michael McCreadie, PricewaterhouseCoopers

49
 8. Tax implications of selling
and buying debt
This section explains the features of the Australian tax
system that are likely to be relevant to a seller or buyer
of distressed assets. However, the following points
may be helpful to consider at the initial planning stage:
• Australia taxes resident taxpayers on
their worldwide income and capital
gains, but non-residents only on their
Australian-sourced income and in
respect of capital gains, from Australian
land and branch assets
• That said, Australian resident companies
are often exempt from tax on dividends,
and capital gains in respect of 10%
or greater shareholdings in foreign
companies. Much of a companies'
foreign branch income is also
exempt from tax
• The company tax rate is a flat
30% but progressive tax rates for
individuals reach 46.5% (including
a "Medicare Levy" at the standard rate)
• Australia imposes 30% withholding tax
on "unfranked" dividends paid to non-
residents (although most tax treaties
reduce this rate to 15% or less). There
is no tax on the remittance of branch
profits to a foreign head office
• The Australian "dividend imputation"
system addresses multiple taxation of
company profits by granting resident
shareholders a credit for any Australian
company tax on the profits from
which dividends are paid
50
• Non-resident shareholders do not fully
participate in the "dividend imputation"
system. Instead, dividends they
receive out of taxed profits are exempt
from withholding tax. A separate
withholding tax exemption applies
to "conduit foreign income"
• Australia imposes a 10% Goods and
Services Tax (GST), similar to the
Value-Added Tax (VAT) imposed in
many European and other jurisdictions.
Exports are usually zero-rated. Financial
supplies are usually input-taxed
• The Australian States and Territories
impose duty on transfers of Australian
land, and some interests in entities that
are Australian land-rich. Depending on
the jurisdiction, the duty will be 4% to
6.75% of the value of the land
• The Australian Capital Territory,
New South Wales and South Australia
still impose 0.6% duty on transfers
of unlisted shares and units (from
1 July 2009, 0.3% duty in NSW)
• NSW and SA also still impose duty on
most non-residential mortgages at rates
of 0.4% and 0.15% respectively.
 The taxation consequences from
the acquisition of debt will depend
on a number of factors, including
whether the debt is acquired directly
or through an acquisition of shares
in a company holding the debt.
The “Buy Side”
The taxation consequences from the
acquisition of debt will depend on a
number of factors, including whether
the debt is acquired directly or through an
acquisition of shares in a company holding
the debt. In the latter case, the taxation
consequences will depend on a number
of additional factors. These taxation
consequences are summarised below
in respect of various forms of acquisition
and holding of the debt after it is acquired.
It should be noted that the comments
below are based on an assumption that
the acquired debt is a “debt interest”
for tax purposes and is not an “equity
interest”. The taxation consequences
will be different for a holder of a debt
instrument which is classified as an
“equity interest” for tax purposes.
For example, distributions on an
“equity interest” will be treated in a similar
way to dividends from shares, that is they
will be frankable and imputation credits
will be available to the investor.
Briefly, a “debt interest” is a financing
arrangement under which one party has
an effectively non-contingent obligation to
pay back financial benefits of at least the
same value as the amount advanced to
it. This test is complex and its application
will depend on the specific facts
of each arrangement.
Acquisition of debt
An acquisition of debt may be effected by
way of a purchase, transfer, assignment,
novation or a similar transaction. This
guide does not cover acquisitions which
are conditional and part of a larger
arrangement (e.g. securities lending).
Briefly, an acquisition of debt is similar to
an acquisition of any other asset – the
amount paid for it becomes its “cost”
for tax purposes. If a debt is acquired
cum interest, that is between the coupon
dates, any amount paid to the seller in
compensation for the accrued interest
is also included in the cost amount.
The tax “cost” is important, for example,
if the debt is subsequently sold,
the difference between the proceeds
received from the sale and the “cost”
will be included in assessable income
of the seller or allowed as a deduction
as taxable income or a tax loss.
Where a particular debt is acquired
together with other assets, the
purchase price is allocated between
the assets in proportion to their market
values, as determined by the parties
or an independent valuer.
Any expenses incurred by the investor
in making the acquisition will be subject
to the ordinary deductibility rules.
For example, ongoing expenses of
a revenue character will normally be
deductible, whereas capital expenditure
may be included in the cost of the acquired
asset (e.g. shares in the company holding
the debt) or deducted over 5 years.
Acquisition of shares of a
company holding the debt
Instead of acquiring debt directly, the
investor may acquire shares in a company
that holds the debt. In this case, the
taxation consequences will depend
on whether the acquired company
experiences a more than 50% change in
its shareholders and whether the company
joins the investor’s tax consolidated group.
51
 More than 50% change in shareholders
Broadly, where the acquisition of shares results in an
at least a 50% change of the company’s shareholders,
the availability of bad debt deductions in respect of
the debt held by the acquired company will depend
on a number of factors.
The change in shareholders is determined for the
period starting from the date the debt was incurred by
the company and ends on the last day of the income
year during which the company seeks to claim a bad
debt deduction in respect of the debt. If there was a
more than 50% change in the ultimate shareholders of
the company, in order to claim a bad debt deduction
in respect of the debt, the company must carry on
the same business as it was immediately before
the ownership change during the income year in
which the bad debt deduction is claimed.
Example
On 1/7/01, an investor acquires all shares in
Company A holding debt acquired on 1/3/01.
Company A has income year ending on 30 June.
On 1/9/03, Company A ascertains the debt as
non-recoverable and writes it off for accounts.
Company A did not maintain the same
shareholders during the period from 1/3/01
(when the debt was acquired) to 30/6/04 (the
end of the income year in which the bad debt
deduction is claimed). This is because all shares
in the company were acquired by the investor on
1/7/01, resulting in a 100% shareholder change.
Unless Company A carries on the same
business during the entire 02/04 income year
(i.e. from 1/7/03 to 30/6/04) as it was carried
on 30/6/01 (immediately before the ownership
test was failed), no deduction will be available
to Company A for the debt write-off.
52
The same business test is a strict test and requires
the company to carry on exactly the same business.
The test may be satisfied for immaterial or organic
changes in the business.
If the debt is forgiven instead of being written off,
more complex provisions dealing with unrealised
losses will apply to determine whether a deduction
in respect of a debt is allowed. These provisions
may allow a deduction or capital loss notwithstanding
the company failing to carry on the same business
(e.g. where a company does not have a net unrealised
loss at the acquisition time) or disallow a capital loss
or deduction even where the same business test has
been satisfied after the acquisition (in some cases
where the company leaves a tax consolidated group).
The investor’s expenses in respect of the acquisition
should be included in the cost of the shares for
tax purposes, unless the investor is in the share
trading business and the shares are acquired
as part of that business.
Acquisition of shares into
a tax consolidated group
Where the investor is a member of a tax consolidated
group and acquires all shares in a company holding
the debt, the acquired company will join the
investor’s tax consolidated group.
The tax consolidation provisions are highly technical
and it is strongly recommended to seek advice on
the taxation consequences related to consolidation.
Briefly the following matters should be considered:
• Tax costs of certain assets of the acquired company
will be “reset”, but tax costs of debts are likely
to be their face values
• If the acquired company has already claimed a bad
debt deduction in respect of a debt, no bad debt
deduction will be available after the acquisition,
even where the share price includes an amount
in respect of the written off debt
It is expected that the TOFA legislation
will be enacted in 2009 which will require
that most large taxpayers recognise interest
income on an accrual basis for tax purposes.
• If the acquisition results in a change
in more than 50% of shareholders of
the acquired company between the
date the debt was incurred and the
acquisition date, the company must
test whether it was carrying on the
same business during that time (i.e.
prior to the acquisition). If it did not,
post-acquisition bad debt deductions in
respect of this debt may not be available
• If the debt is forgiven instead of being
written off, more complex provisions
dealing with unrealised losses will
apply, as noted above.
Holding the debt
Once debt is acquired, the investor will
become entitled to a return from the
debt (e.g. interest), the investor may sell
or convert the debt, the debt may be
collected or written off as bad. Taxation
consequences from these scenarios
are summarised below.
Interest income
Generally, interest paid by the issuer
of the debt is included in assessable
income of the holder on a due and
receivable basis (but see the comment
on the Taxation of Financial Arrangements
(TOFA) rules below).
There are two main exceptions to this rule:
• The holder is a financial institution,
in which case it is required to account
for interest on an accrual basis
• Some debt, if originally issued at a
discount or premium, may require
the holder to account for an amortisation
of the discount or premium on an
accruals basis. Accordingly, if the
purchased debt was originally issued
at a discount or premium, advice should
be sought on the taxation treatment
of the remaining discount or premium.
If the debtor is not able to pay interest
and one of these exceptions applies,
the interest will continue to be included
in the holder’s assessable income even
if no payments are made, unless the
holder and debtor agree to suspend
an accrual of the interest.
If interest is paid by a non-resident,
it may be subject to a foreign withholding
tax. The investor may be able to apply that
withholding tax to reduce its Australian
tax liability for the year in which the tax
was paid. In some cases, the debtor may
request from the investor a certificate
of residency which confirms that the
investor is a tax resident in Australia.
These certificates are requested by
some foreign tax authorities to allow
the debtor to apply a lower rate of
withholding tax and are issued by
the Australian Taxation Office (ATO).
It is expected that the TOFA legislation
will be enacted in 2009 which will require
that most large taxpayers recognise
interest income on an accrual basis for tax
purposes. The legislation is expected to
commence on 1 July 2010, but relevant
taxpayers will be able to elect to apply
it to income years (including substituted
accounting periods) commencing
on or after 1 July 2009.
53
 The TOFA rules are complex and change the current
taxation treatment of financial arrangements, including
debts, by prescribing a number of methods, some of
• Writing off all or part of the debt – the holder
which are elective, to recognise income or losses from
financial arrangements for tax purposes.
Converting debt
The holder may choose to convert the debt to another
instrument, normally equity in the issue of the debt,
if the debt agreement allows such a conversion.
Briefly, the tax cost of shares received from the
conversion will be equal to the cost of the debt
and incidental expenses related to the conversion
and no gain or loss will generally arise.
Alternatively, a deduction for the difference between
the value of the received shares and the debt amount
may be allowed to the creditor if the creditor bought
the debt in the course of its business of lending
money. In this case, the tax cost of shares will
be equal to their market value.
Outcomes for creditor if debtor has
difficulties in servicing the debt
If the debtor has difficulties in servicing the debt,
the following outcomes may be possible:
• Payments are below the required payments
– unless the debt agreement and a subsequent
agreement between the debtor and creditor
specifies otherwise, the creditor will be deemed
to receive interest before principal. For example,
where the required payment is A$100 interest
• Legally forgiving the debt – the creditor may
and A$10 principal, but only A$90 payment
is made, the creditor will be required to deem
this payment as interest only.
• Changes to the debt agreement – the parties
may choose to renegotiate the debt agreement
to provide for a change in the payment schedule,
etc. These changes may result in a debt for
tax purposes being converted into an “equity
interest”, return from which will be deemed to
be a frankable distribution. Renegotiation of the
54
debt agreement will require detailed consideration
of the taxation consequences.
may re-assess the recoverability of the debt and
choose to write-off all or part of the debt in its
accounts. However, a corresponding deduction
will only be available where:
− The debt exists at the time of the writing off
(i.e. it has not been extinguished, etc)
− The debt has actually gone “bad”, that is,
for example, reasonable recovery attempts
have failed, the debtor is in liquidation,
etc. A mere expectation of a default
is not sufficient for a deduction
− The holder bought the debt in the ordinary
course of the holder’s business of lending money.
The deduction is limited by the amount the debt
was bought for
− Forgiveness of accrued interest incurred after
the purchase will give rise to a deduction
only if the interest has been included in the
holder’s assessable income or if interest can
be classified as debt in respect of money lent by
the holder in the course of the holder’s business
of lending money
− See comments above regarding when the debt
is held by a company purchased by the investor
− Future recoupments of a debt written
off for tax purposes will be included in
the holder’s assessable income.
choose to legally forgive all or part of the debt,
therefore fully or partially discharging the debtor.
A discharge is likely to give rise to a deduction
or a capital loss for the holder; however, the
exact amount of the deduction will depend on
the specific facts of each case. Further, the
forgiveness may also result in taxation implications
for the debtor and/or debtor’s group entities
under the commercial debt forgiveness rules.
Lore veliquatem irit pratie te magna at.
Met laore feugue consequi elissim dolendi
onsequat feugue ratie te magna at met
laore feugue consequi elissim dolendions.

Incidental expenditures of the holder • Debt may also be acquired by a trustee of a trust.
If a trust is a fixed trust, that is its beneficiaries
• Broadly, the purchaser and holder of the debt
are entitled to a fixed share of the trust’s income
should be entitled to a deduction for incidental
(e.g. a unit trust), it is the beneficiaries and not the
expenditures incurred in acquiring and holding
trustee who should generally be assessed for tax
the debt as those expenditures are incurred.
in respect of their entitlement.
This will include legal fees, factoring fees, etc.
Where all or some of the beneficiaries are non-
However, where an expenditure is of a capital
residents, and the trust qualifies as a “managed
nature, for example, due diligence fees in respect
investment scheme”, income from collection and
of an acquisition of a business together with debt,
disposal of Australian debts (but not interest) to which
the deductibility may be restricted by including
foreign beneficiaries are entitled to, may be subject
the expenses in the tax cost of certain assets
to a reduced rate of final Australian withholding tax.
or allowing a deduction over 5 years.
Australian stamp duty
Overseas matters
Australian stamp duty is a State-based tax
Generally, the above rules apply to debts where a
imposed on transactions and legal documents.
debtor or creditor is a non-resident. However, the
There are eight different sets of rules governing
following considerations should be kept in mind:
stamp duty in Australia.
• Where the debtor is a non-resident, interest
There is no logic or uniformity to the various regimes.
payments and payments in the nature of
However, outlined below are some of the broad stamp
interest (e.g. discounts) may be subject to
duty issues which will need to be considered by the
a foreign withholding tax. The creditor may
buyer of distressed assets, as the obligations to pay
reduce its Australian tax by the foreign tax
duty generally fall on the buyer. Given the complexity
withheld from interest
and differences in the rules for each jurisdiction,
• Where the debt is held by a foreign branch of the the actual stamp duty exposure will depend on
Australian holder and income of the branch is the circumstances of the particular transaction.
exempt from Australian tax, no bad debt deduction
• Transfer duty is imposed on the acquisition
in respect of the debt will be available, even
of assets located in Australia. Assets which
though legally the debt is held by an Australian
are subject to duty, in some or all jurisdictions,
taxpayer and other conditions for the bad debt
include land and buildings, business assets
deduction are satisfied
(e.g. plant and equipment, goodwill, intellectual
• Any transfers of the debt between international property, trade debts etc.). The rates of duty
related parties must be on arm’s length terms vary in each jurisdiction and among jurisdictions
but can be as high as 6.75%. Duty is calculated
• If the debt is held by an Australian branch of a on the greater of the market value of the asset
non-resident, the rules above will generally apply and the consideration paid (inclusive of GST).
to the branch. However, if the debt is held by a Accordingly, the stamp duty exposure on the
non-resident not through a branch in Australia, acquisition of distressed assets will depend on the
the acquisition, holding and disposal of the debt nature of the distressed assets and their location.
should not have Australian taxation consequences
for the non-residents

55
 • Transfer duty may also apply to any subsequent
transfer of the assets between entities of the buyer’s
own corporate group. However, any intra-group
transfer may qualify for corporate reconstruction
relief but formal application for relief is required
to be made.
• Where the distressed assets include shares
or units, marketable securities duty is payable
in New South Wales, the Australian Capital Territory
and South Australia on the transfer of shares
in unlisted companies and unit trusts connected
with those jurisdictions. Marketable securities
duty is imposed at 0.6% (or 0.3% in South Australia
from 1 July 2009) on the higher of the market value
of the shares/units and the consideration paid.
• The acquisition of interests in entities which hold
any land assets located in Australia, either directly
or indirectly or on a consolidated basis, could
also attract land rich or land holder duty. Land
rich or landholder duty is imposed at transfer duty
rates (i.e. up to 6.75%) on the market value of the
underlying land assets (although in one jurisdiction,
duty is imposed on both land and chattels). Broadly,
these provisions effectively deem an acquisition
of an interest in the entity as a direct acquisition
of an interest in the land assets held by the entity
or its associated entities.
56
• In Queensland and South Australia, there are
“trust look-through” provisions that need to be
considered if units in unlisted unit trusts are part of
the distressed assets. These “trust look-through”
provisions operate to treat dealings in the units as
dealings in the underlying assets of the trust located
in South Australia or Queensland and duty is
imposed at transfer duty rates on those assets that
are “dutiable property” located in those jurisdictions.
• If a buyer borrows or finances the acquisition
of distressed assets through secured lending
arrangements, mortgage duty is payable in
New South Wales and South Australia on any
mortgages and charges relating to assets
located in these jurisdictions. Mortgage duty is
imposed at the rate of 0.4% (in NSW) and 0.15%
(in South Australia) on the amount secured
by the mortgages.
• If any leases of real property are entered into where
a premium is paid for the granting of the lease,
transfer duty may be payable.
GST
The GST treatment of the supply of distressed assets
will be determined by the seller. In general, the supply
of distressed assets by a GST-registered seller
will be a taxable supply subject to GST unless the
supply is a GST-free supply (e.g. a “going concern”)
or an input taxed supply (e.g. financial supplies).
The disposal of distressed assets can have
a number of income tax consequences
for the seller. Any gain or loss from a
financial asset (e.g. loan) will generally
be assessable or deductible.
GST on the assets
Where the buyer incurs GST on the acquisition
of distressed assets, the buyer will be entitled
to recover the GST incurred provided:
• it is registered for GST
• the assets will not be used to make input taxed
supplies or are not for private use
• it holds a valid tax invoice.
In circumstances where the buyer incurs GST on
distressed assets and the assets are subsequently
used to make input taxed supplies, the buyer
will not be entitled to recover the GST incurred
on the acquisition.
Where the distressed assets are used to make both
input taxed supplies and either taxable or GST-free
supplies, the GST incurred may be apportioned on a
“fair and reasonable” basis and the proportion of the
GST incurred on the assets relating to the subsequent
taxable or GST-free supplies may be recovered.
The “Sell Side”
Special rules for financial arrangements
The disposal of distressed assets can have a number
of income tax consequences for the seller. Any gain
or loss from a financial asset (e.g. loan) will generally
be assessable or deductible. If the asset carries a
deferred return, the disposal of the security may
trigger a balancing adjustment to take into account
any part of the deferred return which has previously
been included in the seller’s assessable income.
A deduction for a loss made on a financial asset may
be denied in certain circumstances where the loss is
capital in nature and the financial asset is disposed of
because of the possibility of the issuer defaulting.
In the case of assets other than financial assets
(e.g. ownership interests in an entity that owns
distressed assets), losses made on assets held on
revenue account will generally be deductible, whereas
Where the distressed assets are acquired as a
GST-free supply of a going concern and the buyer
subsequently uses the assets to make input taxed
supplies, the buyer will be required to make an
adjustment in relation to GST. The amount of the
adjustment payable to the ATO will be 10% of
the proportion of the purchase price that relates
to making input taxed supplies.
Please note that where the buyer acquires property
under the margin scheme, it will not be entitled
to claim any GST incurred on the acquisition
of the property as an input tax credit.
GST on transaction costs
Where the distressed assets are input taxed financial
supplies or the distressed assets are used for input
taxed supplies, any GST incurred on professional
costs relating to the acquisition of the distressed
assets will generally not be recoverable in full. In these
circumstances, the buyer should determine whether
it exceeds the financial acquisition threshold and
whether it will be entitled to reduced input tax credits.
losses on assets held on capital account will only be
deductible against capital gains or can be carried
forward to be offset against future capital gains.
Where the ownership interest is an equity interest in
an Australian company, care will need to be taken
that the disposal does not result in the denial of the
benefit of any franking credits attached to dividends
which may be paid to the seller.
Assets denominated in foreign currency
Where the distressed asset or ownership interest is
denominated in foreign currency, gains or losses which
arise as a result of fluctuating exchange rates between
the date of disposal and the date of payment are
generally assessable or deductible, respectively.
57
 New tax-timing rules
New TOFA tax-timing rules will apply to income
years commencing on or after 1 July 2010
(or 1 July 2009, if a taxpayer elects). The new rules
will effectively remove the capital/revenue distinction
for eligible taxpayers and allow them to rely on
their financial accounts in determining their tax
liability if they so elect.
Debt restructuring
In general, the sale of distressed assets by an entity,
likely to be undertaken to raise funds to enable
debts to be repaid, will give rise to either gains or
losses for income tax purposes. Any gains made
on the sale of distressed assets will be assessable.
Losses made on the sale of distressed assets will
generally be deductible. Losses made on the sale
of non-depreciating assets held on capital account
can only be deducted against capital gains.
Entities should be aware, however, that in certain
circumstances amounts may be included in
assessable income where assets have been acquired
under limited recourse financing arrangements
and, upon termination of that debt (which may be
expected to occur in conjunction with the sale of
the asset), the amount owing is not fully repaid.
Broadly, assessable amounts may arise where
capital allowance deductions (such as depreciation)
are considered to have been claimed excessively
over the life of the asset.
Further, amounts may also be included in
assessable income in respect of the sale of leased
plant by an entity, again in circumstances where
depreciation has been deducted in respect of the
asset. Broadly, this may occur where a liability of the
entity is reduced as a result of the sale of the asset,
for example, on the entity receiving a benefit in the
form of being relieved of a debt.
It is important to consider the tax impact of these
“recoupment” type provisions when determining how
best to deal with distressed assets, as their application
may result in an entity receiving significantly less
value than first anticipated on the sale of an asset,
therefore potentially affecting the entity’s course
of dealing with that asset.
58
If the new rules apply to the seller of a distressed
asset, the disposal of the distressed asset will
generally result in a balancing adjustment which
will require the seller to recognise an assessable
gain or a deductible loss. The new rules will
not apply to the disposal of an equity interest
(e.g. ordinary shares) if the seller has not elected
to rely on their financial accounts for tax purposes.
Entities with distressed assets may also look to
restructure their debt through debt defeasance
arrangements. Such arrangements allow a debtor,
with a liability to repay a loan at some future date,
to pay a third party a reduced amount (e.g, the current
present value of the future liability) in consideration
of the third party assuming the liability to repay the
amount owed by the debtor when it becomes due.
This may include situations where the distressed
assets are sold to finance the up-front payment
to the third party.
With the exception of finance entities, savings made
by an entity under debt defeasance arrangements
will typically not be treated as ordinary income,
but are likely to fall for consideration and give rise
to consequences under the CGT provisions.
In circumstances where distressed assets
are transferred directly by an entity to discharge
a debt, tax implications under the commercial debt
forgiveness provisions may also arise, depending
on the market value of the assets and the market
value of the debt at the time the debt is extinguished.
Debt may also be restructured via the dealing
with distressed assets under sale and leaseback
or hire purchase type arrangements but entities
should also seek to confirm the tax implications
in advance of entering into such arrangements.
For example, in broad terms, the ability of a lessee
or hirer to obtain depreciation deductions in respect
of the assets is likely to depend on the existence
of a right, or obligation, to purchase the asset at
the end of the term of the arrangement.
The new tax-timing rules will effectively
remove the capital/revenue distinction for
eligible taxpayers and allow them to rely
on their financial accounts in determining
their tax liability if they so elect.

Equity restructuring
Selling a subsidiary member Selling a foreign subsidiary
of a consolidated group Where the shares of a foreign subsidiary are sold, a
capital gain or capital loss will be triggered. However,
Where the shares of a subsidiary member of a
where the shares were held by an Australian resident
consolidated group are sold, the subsidiary member
company that held a direct voting percentage of at
will leave the consolidated group (leaving subsidiary).
least 10% in the foreign company for a continuous
This will trigger a number of tax consequences for the
period of at least 12 months in the 2 years before the
head company of the consolidated group as follows.
sale, the capital gain or capital loss can be reduced.
• The head company will be required to recalculate
The capital gain or capital loss is reduced by
the cost base of the shares of the leaving subsidiary.
the foreign company’s “active foreign business
The cost base is broadly equal to the cost base of
percentage”. The “active foreign business
the assets that the leaving subsidiary takes with it
percentage” is the value of the foreign company’s
minus the value of the leaving subsidiary's liabilities.
active business assets as a percentage of the
• Using this recalculated cost base, the head value of the foreign company’s total assets.
company will be required to determine whether
The Australian resident company can choose to value
it has made a capital gain or a capital loss
the foreign company’s assets at either book value or
from the share sale.
market value, but if either of those methods cannot
• Where the leaving subsidiary's liabilities exceed be used, or if no choice is made, a default method
the cost base of its assets, the head company will applies under which capital gains are fully taxable and
make a capital gain under CGT event L5 equal capital losses are reduced to nil. If the “active foreign
to that excess. business percentage” is less than 10%, it is rounded
down to zero (so that a capital gain becomes fully
• For the leaving subsidiary, leaving a consolidated taxable) and if it is greater than 90%, it is rounded
group may trigger an obligation to make a up to 100% (so that a capital gain is reduced to zero).
payment to the head company under a tax sharing
agreement to enable the subsidiary member
to leave the consolidated group clear of any joint
and several liability to pay the group's tax liabilities.
In addition, any tax losses, franking credits or other
tax attributes of the consolidated group will remain
with the head company and will not be passed
to the leaving subsidiary.

59
 Paying for others’ mistakes
The disposal of distressed assets can have income
tax consequences for parties beyond the seller where
there is a certain type of fiduciary relationship between
the seller and a third party in particular circumstances.
Such third parties include agents, trustees, liquidators,
receivers and directors of the seller.
Under special rules which can apply, such a third
party may become personally liable to discharge
certain tax liabilities of the seller (in the case of agents,
Indirect tax
The GST treatment of supplies of distressed assets
will depend on a number of factors including:
• The legal capacity of the seller
• The character of the distressed asset being supplied
• The entity responsible for the GST consequences
of the supply
• Whether the assets being supplied would otherwise
be GST-free or input taxed under the GST Law.
In general, the supply of a distressed asset by a
GST-registered seller will be a taxable supply subject
to GST unless the supply is a GST-free supply
(e.g. a "going concern") or an input taxed supply
(e.g. financial supplies). For each supply, the seller
will also need to consider whether an adjustment
is required for GST input tax credits claimed at the
time the asset was acquired.
Difficulties can and do arise for GST purposes where
the seller is a representative (e.g. administrator,
receiver, liquidator) of an "incapacitated entity"
(e.g. an entity that is in liquidation or receivership).
60
trustees, liquidators and receivers), be jointly and
severally liable to pay administrative penalties (in the
case of company directors where a selling company
has failed to comply with a tax law) or be deemed to
have committed a taxation offence in relation to an
act or omission done by the company (in the case of
company directors where a company has committed
a taxation offence).
The ATO takes the view that a representative of an
incapacitated entity will be liable for GST, entitled to
GST input tax credits, and has adjustments, in respect
of supplies and acquisitions it makes from the date
it is appointed as representative of the incapacitated
entity. The incapacitated entity will continue to be liable
for GST on supplies and entitled to GST input tax
credits on acquisitions made prior to the appointment
of the representative, subject to an exception
relating to adjustments.
Further, where a mortgagee in possession sells
property in satisfaction of a debt owed by a debtor,
the mortgagee in possession will be responsible
for the GST consequences of the supply.
Where the asset being supplied is real property,
the characteristics of the property will determine
whether it is a taxable, GST-free or input taxed
supply of real property. If the real property being
supplied is taxable, the seller should consider
whether the "margin scheme" will apply to the supply.
 Perspective

• Selling or buying distressed assets in Australia involves

complying with a complex range of taxation requirements
and record keeping responsibilities.

• Both buyers or sellers need to consider the tax implications of

the investment vehicle and the structure of the transaction at an
early stage to minimise the risk of unanticipated tax exposures
and to help maximise taxation opportunities.

• All aspects of taxation need to be considered including

income tax, capital gains tax, withholding tax, GST and stamp duty.

• Foreign investors also need to consider their international

tax arrangements.

61
 Appendix A –
Economic outlook

Global economic outlook

The current global economic landscape bears little
resemblance to this time last year. With in excess of
US$1 trillion lost in write-downs to date, and the IMF
revising forecasts of total losses upwards to US$2.2 trillion,
it appears that a return to normality is still a way off. What
we are currently witnessing is a massive adjustment in the
global economy, from an environment of cheap and plentiful
debt to one of debt scarcity. The impact of this adjustment
has now flowed from Wall Street to the main street economy.

The IMF has subsequently slashed its Australian

average global growth forecasts, down
from 1.75% in November 2008 to 0.5%
by January 2009. But averages hide the
sizable diversity in growth rates between
countries. The economies of developed
nations are forecast to contract by
an average 2.0% during 2009. Much
therefore hinges on China and India, the
world’s 3rd and 12th largest economies
respectively. The IMF forecasts 6.7% and
5.1% respective annual growth for
these economies, hence the positive
global average. However even these
forecasts have been revised downwards
over the course of the last four months,
with much now resting on their ability to
show agility in developing new export
markets and growing their massive,
but underdeveloped, domestic economies.
economic outlook
The outlook for the Australian economy
has deteriorated in line with global trends
and now faces the prospect of entering
a recession in the first half of 2009.
Consensus has moved away from a soft
landing to a rockier landing and periods
of sustained distress for certain industries.
Our Australian Economic Outlook sees
GDP growth slowing from the 2.1%
during 2008 to between 0 - 0.5%
during 2009. Therefore, Australia’s
position is relatively bright in relation to
other developed countries. The prime
reason for this is a stronger financial
sector that has resulted from superior
credit policies and risk management
strategies. The recent Government
move to guarantee bank deposits
has further strengthened the sector
and ensured that confidence remains.

62
However, the fortunes of the Australian
economy are still deeply entwined
with international factors including:
• The negative financial contagion effect
where assets and industries in Australia
become negatively affected by declines
in asset values which originated
in the US
• A softening in commodity prices,
accompanied by a sharp slowing in
demand has seen Australian resources
facing both a contraction in the value
and volumes of exports. The results
have been mine closures, deferment
of infrastructure and asset sales
• Health of top export markets, Japan,
China and South Korea which together
account for 39% of total exports.
The Japanese and South Korean
economies have been two of the
hardest hit, while the performance
of the Chinese economy is being
keenly watched from around the
world. Sustained contractions in
these markets, implying reduced
demand for Australian commodities,
will hurt Australian businesses and
strain Australia’s terms of trade
On the domestic front, a number
of factors influencing our outlook
for the coming period include:
• A slow rise in unemployment towards
6 – 7% (currently 4.5%), affecting
all sectors and States
• A weakening Australian property
market with more suburbs and market
segments experiencing declines.
However, our property prices are
traditionally sticky on the downside,
most cities have housing demand
exceeding new supply, and the recent
Federal stimulus package contained
an increase in new home owner grants
that could buoy demand
• Falling levels of inflation as petrol prices
soften and consumer confidence
levels remain low
• Increases in household savings rates,
as spooked consumers choose to pay
down debt and lock away wealth as
the short-medium term outlook remains
uncertain. This has the important side
effect of blunting the effectiveness
of fiscal stimulus packages designed
to boost consumer spending.
However considerable attention will also
be paid to the impact of rapid monetary
and fiscal responses. While these
responses will not counter the structural
adjustment currently taking place in the
global economy, it has signalled policy
makers’ willingness to cushion the blow
to the Australian economy. Australia was
fortunate to have a strong fiscal position
prior to the onset of the crisis. The second
fiscal package recently announced
shows a willingness to fully exploit this
position and even put the budget into
deficit in order to prop up spending. The
announced package also coincided with
a further 100pb cut to official interest rates,
bringing them to a record low of 3.25%.
These actions mirror the policies of other
G-20 nations in a coordinated attempt to
stave off a prolonged global recession.
Combined, these actions should moderate
the recent rapid growth in non-performing
loans, however the extent to which they
reaffirm confidence and stabilise the
economy remains to be seen.
63
 Appendix B –
Summary of Australian
Big 4 Banks Basel II disclosures

The following provides a summary of the ANZ, CBA, NAB and Westpac’s Basel II disclosures (also known
as Pillar 3 or APS330 disclosures). The figures for ANZ, NAB and Westpac are as of 30 September 2008,
whilst CBA is as of 30 June 2008.
The table below provides a summary of the carrying value of defaulted assets which is defined as being 90 days
past due or unlikely to pay.
Risk-Weighted Risk-Weighted
Exposure Assets Exposure Assets

A$m A$m porportion of porportion of

Non-defaulted assets 2,131,013 655,947 99.5% 95.9%

Defaulted assets - Corporate 6,741 16,891 0.3% 2.5%

Defaulted assets - Consumer/Personal 4,382 11,407 0.2% 1.7%

Total 2,142,136 684,244 100.0% 100.0%

Source PricewaterhouseCoopers

Based on the above the big 4 banks in Australia are carrying a total of A$6.7 billion in corporate loans that
are at least 90 days past due and A$4.3 billion of consumer related loans.
The following table provides a summary of the total lending, defaulted loans, impaired loans and specific provisions
on the balance sheets by industry for the Big 4. The total write-offs represent loans written off to the profit and loss
for the respective year ends collectively for the big 4 banks. These write-offs are typically taken as either a charge
to the specific provisions or a charge to the collective provisions for credit losses. The big 4 banks have written
off a total of A$1.4 billion in consumer and A$1.0 billion in corporate loans for the 12 month period.
As can be seen in the table below Specific Provisions are considerably lower than the value of Impaired Loans. In many
cases a bank may not be able to accurately estimate the Individual/Specific Provision, in which case it will estimate the
credit risk provision on a collective basis. The collective provisions for the Big 4 banks were approximately A$8.0 billion.
By far the largest exposure for defaulted loans is the Personal sector, which includes a considerable volume
of residential mortgages. On the Corporate side the largest exposure is in the property and business services
sector with total of A$2.1 billion in defaulted loans.

64
 Defaulted Impaired
Industry Exposure Specific Write-Offs
Loans Provisions

A$m A$m A$m A$m A$m

Accommodation, cafes, pubs and restaurants 24,975 177 120 33 16

Agriculture, forestry, fishing and mining 111,223 434 320 91 46

Construction 30,996 453 365 83 40

Finance and surance 377,898 1,100 939 290 209

Manufacturing 98,263 666 608 305 150

Personal * 983,996 4,382 1,411 614 1,442

Property and business services 230,363 2,113 1,659 249 192

Trade 93,771 815 488 211 196

Transport and storage 46,146 145 112 46 37

Energy 17,611 2 0 0 -6

Sovereign 22,897 0 0 0 0

Other 103,997 836 600 300 103

Total 2,142,136 11,123 6,682 2,222 2,425

Source PricewaterhouseCoopers

65
 Useful websites
BLAKE DAWSON
www.blakedawson.com
The Blake Dawson website includes information about the firm, updates on recent legal developments,
partner profiles and contact details.

PRICEWATERHOUSECOOPERS
www.pwc.com/au/car
PwC’s Corporate Advisory & Restructuring division is a dedicated team of specialists with extensive
skills in diagnosing, advising on and deploying commercial solutions for underperforming, inefficient
or distressed organisations and those confronted with unexpected events.

ASIA-PACIFIC LOAN MARKET ASSOCIATION

www.aplma.com
The Asia-Pacific Loan Market Association is the trade association for the syndicated loan trading
market in the region.

AUSTRADE
www.austrade.gov.au
The Australian Trade Commission (Austrade) is the Australian Government’s trade and investment
development agency.

AUSTRALIAN BUREAU OF STATISTICS (ABS)

www.abs.gov.au
The ABS website provides statistics for a wide range of economic and social indicators.

AUSTRALIAN LEGAL MATERIALS (LEGISLATION AND CASE LAW)

www.law.gov.au
An online resource providing information about the Australian legal system and relevant
government organisations.
www.austlii.edu.au
This website provides access to Australian legal materials.

AUSTRALIAN SECURITIES EXCHANGE (ASX)

www.asx.com.au
ASX operates Australia’s primary national stock exchange.

CORPORATE REGULATION
www.asic.gov.au
The Australian Securities and Investments Commission regulates Australia’s companies.

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DEBTWIRE
www.debtwire.com
Debtwire is a commercial information provider to the fixed income markets. It publishes regional surveys
of distressed debt markets.

FOREIGN INVESTMENT
www.firb.gov.au
The Foreign Investment Review Board examines proposals by foreign interests to undertake direct
investment in Australia.

GOVERNMENT INFORMATION
www.gov.au
The Government Entry Point provides access to Australian Federal, State, Territory and Local
Government websites.
www.business.gov.au
The Business Entry Point is a government resource for business.

INSOLVENCY PRACTITIONERS ASSOCIATION OF AUSTRALIA

www.ipaa.com.au
The trade association for Australian insolvency professionals.

LOAN MARKETING ASSOCIATION

www.lma.eu.com
The European trade association for the syndicated loan trading market.

LOAN SYNDICATION AND TRADING ASSOCIATION

www.lsta.org
The Loan Syndications and Trading Association is the US association for the syndicated loan trading market.

PROPERTY
www.propertyoz.com.au
The Property Council of Australia is the peak industry body for the Australian commercial real estate sector.

TAXATION
www.ato.gov.au
The Australian Taxation Office’s website includes information for business, large corporates and multinationals.

TMA
www.turnaround.org.au
The Turnaround Management Association is the only international non-profit association dedicated
to corporate renewal and turnaround management.

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 Contributing authors

Blake Dawson
Michael Sloan
Partner, Restructuring & Insolvency
Duncan Baxter
Partner, Tax
Craig Boyle
Senior Associate, Tax
Carl Della-Bosca
Partner, Corporate
Jemaya Mackie
Senior Associate, Restructuring & Insolvency
James Marshall
Partner, Restructuring & Insolvency
Matthew May
Partner, Corporate
Stephen Menzies
Partner, Corporate
Paul O’Donnell
Partner, Tax
Paul Pyanic
Senior Associate, Tax
David Ryan
Partner, Corporate
Marcus Ryan
Senior Associate, Tax
Steve Smith
Partner, Financial Services
Natasha Thomson
Senior Associate, Restructuring & Insolvency
Sanjay Wavde
Senior Associate, Tax

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PricewaterhouseCoopers
Michael Codling
Partner, Financial Assurance
Nick Colman
Manager, Distressed Debt Group
Melissa Humman
Senior Manager, Corporate Advisory and
Restructuring
Frank Janik
Director, Distressed Debt Group
Chris Kinsella
Partner, Tax and Legal Services
Paul Kirk
Partner, Corporate Advisory and Restructuring
Scott Lennon
Partner, Economics and Strategy
Steven Lim
Partner, Actuarial Services
Michael McCreadie
Partner, Distressed Debt Group
Rob Spring
Partner, Financial Assurance
Tom Toryanik
Senior Manager, Tax and Legal Services
Rob Tyson
Senior Consultant, Economics and Strategy

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Contact information

For further information, please contact:

Blake Dawson
James Marshall
Partner, Sydney
Restructuring & Insolvency
T 61 2 9258 6508
james.marshall@blakedawson.com

PricewaterhouseCoopers
Michael McCreadie
Partner, Melbourne
Distressed Debt Group
T 61 3 8603 3083
michael.mccreadie@au.pwc.com

www.blakedawson.com www.pwc.com/au