Ongoing concern: The Asian CFOÆs debt hangover

"Material adverse changes, which raise substantial doubt about its ability to continue as a going concern" is one example of a fairly innocuous phrase which can have profound implications for a corporation’s survival. It is an auditor’s going concern qualification – something chief financial officers are becoming increasingly familiar with as the recession tightens its Darwinian grip on debt-laden corporations.

According to research firm Audit Analytics, more than 23% of public company filings made in the US for fiscal years ending between June 30 and December 31, 2008, included a going-concern qualification. But just how often is an auditor’s going concern qualification likely to appear in Asia?

A recent paper from the World Bank suggests a worrying trend. The bank says that the rollover of maturing debt, especially for commercial banks and corporations within emerging markets that either have no, or limited, access to domestic capital markets, constitutes a key risk to their survival. The bank estimates that over $1 trillion in emerging markets corporate debt will mature in 2009 and much of that has been extended by international banks which, under pressure from the governments which have bailed them out, are no longer lending across borders.

The result is that Asia faces a unique problem: while anecdotal evidence suggests that the overall level of corporate debt in Asia is at a historical low, the corporate debt that does exist is problematic because corporations could face severe difficulties in refinancing it over the next few years. Indonesia’s central bank, for example, said in February that $17.4 billion of corporate debt will mature in 2009 in Indonesia alone. Indonesia’s finance minister has publicly voiced her concern at the likely difficulties in rolling all that debt over.

We are, in fact, already seeing signs that this problem has surfaced. India’s Business Standard reported at the end of last month that Wockhardt, the pharmaceutical company, had joined the growing list of Indian companies entering into an institutionalised workout programme in order to restructure debt accumulated through over-expansion. The number of companies entering this programme reportedly rose by 300% in 2008-2009, indicating the worsening repayment capability of Indian companies. Fitch Ratings recently released a special report which identifies Asian corporations’ particular reliance upon continuing good banking relationships as key to being able to refinance debt maturing in 2010. It does point out, though, that if banking systems in Asia become stressed, leading to constraints on the availability of credit, current lending practices could change with larger, higher-rated corporations being allowed to refinance, while smaller, weaker corporations, or those already in distress, are being allowed to go to the wall.

The table below, from rating agency Standard & Poor’s, shows emerging market corporate defaults outstripping Europe in 2008. It also hints at the lag between the Asian financial crisis in 1997-98 and its effects, with the number of corporate defaults peaking four or five years later, in 2002. While past performance is, of course, not necessarily a guide to the future, Asia’s recent history certainly points towards the seeds of corporate default having already been sown by events in 2008 and 2009, with a harvest to be expected any time between 2010 and 2013.



As Fitch notes, all this data point to the need for pro-active debt management. This, of course, is not novel; it is something Asian CFOs should have been doing for the past few years - locking-in cheap credit when it was available, with an eye to stewarding their corporations safely through the inevitable change in the corporate cycle. Few CFOs seem to have done this, however; or we would not be seeing the oncoming crisis of debt maturity in Asia. Perhaps, as a result, the role of the Asian CFO will now undergo the kind of microscopic scrutiny which is a feature of litigation against directors and officers. The results could prove an uncomfortable reality check for many Asian CFOs.

Responsibility
The classic statement of the standard of skill to be expected of a director, namely that he or she need not exhibit a greater degree of skill than may reasonably be expected of a person with his knowledge and experience, can be found in an English case which is now almost 85 years old. Times have of course changed since then, as has society’s view of what can generally be expected of the modern corporation’s directors and officers. These expectations were more recently summarised in a US case decided in 1981, where the judge said that directors had a duty to: