Korea Asset Management Corporation (KAMCO): Resolution of Nonperforming Loans in South Korea

In the summer of 1997, Thailand was forced to abandon its currency peg to the US dollar due to a lack of foreign currency reserves (Sharma 2001; King 2001). The financial collapse of the Thai baht triggered a crisis that quickly spread across Southeast Asia, as international investors sought to decrease their exposure in the region. While South Korea had experienced strong growth in both real GDP and consumption in the run up to the crisis, the country started experiencing difficulties as reduced capital inflows revealed structural problems in Korea’s financial and corporate sectors (He 2004; Sharma 2001). After decades operating under a government-supported industrialization strategy fueled by easy credit to the country’s main conglomerates, or chaebols (Baliño and Ubide 1999), the Korean corporate sector had developed a culture focused on gaining “market share rather than profitability along with a capital structure that relied heavily on external borrowing” (He 2004; Baliño and Ubide 1999). Financial liberalization in the 1990s thus left a financial system with eroded lending standards and a banking sector lacking skills in credit analysis and risk management. At this stage, Korean banks largely met domestic demand for funds through foreign borrowing at short maturities. As the crisis reached Korea and foreign capital inflows dried up, the country’s financial sector found itself confronted with severe maturity mismatches and large amounts of nonperforming loans (NPLs) (Baliño and Ubide 1999). The situation was exacerbated by the government’s lax loan classification standards, which had allowed banks to underestimate the amount of NPLs on their balance sheets (He 2004).^FNClassification standards were tightened in March 1998 to align with international standards. Before the crisis, only loans in arrears of six months or more were classified as nonperforming. As banks were required to tighten classification criteria, loans in arrears of three months or more were included.

To prevent a complete collapse of the country’s financial sector, Korean government officials formally requested emergency standby loans from the International Monetary Fund (IMF) in the second half of 1997 (CNNMoney 1997). The crisis management strategy established under IMF guidance focused on four key elements: (1) Restoring stability in the financial system through liquidity support; (2) restoring solvency of the financial system through intervention in nonviable institutions, purchase of NPLs and recapitalization; (3) bringing prudential regulations and supervision in line with international best practices; (4) corporate restructuring measures to reduce corporate distress (He 2004; Chopra et. al 2001).

Because the resolution of NPLs held by domestic financial institutions was considered an important aspect of the strategy for crisis management and financial sector restructuring, the government announced the creation of a nonperforming asset resolution fund to be managed by the publicly operated Korea Asset Management Corporation (KAMCO). KAMCO began executing its new mandate on November 26, 1997, with the purchase of loans with total face value of KRW 4.4 trillion.^FNApproximately $3.5 billion using an exchange rate of KRW 1250 for $1. This rate is computed from the average exchange rate during the five-year purchasing period using daily data from the Federal Reserve of St. Louis. from two systemically important institutions, Seoul Bank and Korea First Bank (He 2004).

In May 1998, the government estimated that the total NPLs of all financial institutions in Korea came to KRW 118 trillion, or 27 percent of GDP. Of that total, KRW 68 trillion had been in arrears for six months or more and were considered prone to default risks. A further KRW 50 trillion in loans had been in arrears for three to six months and were classified as “precautionary.” The government said it would target KRW 100 trillion worth of NPLs for immediate disposal. It would orchestrate the disposals through two channels. Financial institutions themselves would dispose of about half of the loans themselves, either by selling collateral or calling in the loans. KAMCO would purchase and sell the remaining half. Estimates of NPLs in the system subsequently grew later in 1998 and 1999 as the government required banks and later nonbanks to redefine NPLs as in arrears for three months or more and to take into account forward-looking criteria in their credit assessment (He 2004).

KAMCO was founded under the Korea Development Bank Act of 1962 (He 2004) to provide the Korea Development Bank (KDB) with a legal basis for collecting overdue loans. Its scope of business was gradually expanded to include the liquidation of government-invested corporations as well as the public sale of confiscated properties (KAMCO 2012). KAMCO adopted its role in NPL resolution when it was reorganized under the “Act on the Efficient Disposal of Nonperforming Assets, etc. of Financial Institutions and the Establishment of Korea Asset Management Corporation” (KAMCO Act 1997), an amendment to the 1962 KDB Act passed in August 1997 (KAMCO 2012). Under the new framework, an NPL resolution fund was established and mandated to raise funding and purchase NPLs over a period of five years until November 2002 (Cerruti and Neyens 2016). The initial act was amended several times between 1997 and 1999 to “[strengthen KAMCO’s] asset management and disposition capabilities” (Baliño and Ubide 1999), allowing additional business functions and a more active involvement in corporate restructuring efforts (Lee 2011). While the NPL fund was initially established without a sunset date, a December 2006 amendment to the KAMCO Act specified that the fund would cease its NPL resolution operations by November 2012, 15 years after being established (KAMCO Act 1997).

Under the Act, KAMCO was reorganized as a special resolution agency with the status of a public nonbank financial corporation supervised by the Financial Supervisory Commission (FSC)^FNThe Financial Supervisory Commission served as South Korea’s main financial regulator during the Asian crisis. It was renamed the Financial Services Commission in 2008. and governed by a Management Supervisory Committee consisting of 11 members. (He 2004; Lee 2011). Its NPL fund was monitored by the Public Fund Oversight Committee, led by the Ministry of Finance and Economy (MOFE) (Cerruti and Neyens 2016). The KAMCO Act also revised the agency’s ownership structure (KAMCO Act 1997). KAMCO, which had until then been a subsidiary of the KDB, issued shares for a total capital of KRW 1 trillion by 1999 (Baliño and Ubide 1999; KAMCO Act 1997; Cerruti and Neyens 2016). A large majority of its shares remained government owned with the MOFE as majority shareholder owning 42.8%, followed by the KDB with 28.6%. The remaining 28.6% of shares were held by other financial institutions (He 2004).

KAMCO’s NPL resolution fund purchased nonperforming assets from distressed financial institutions over a five-year period, from November 1997 to November 2002. In line with its mandate, KAMCO considered as eligible for purchase only those loans “whose security rights and transfer were legally executable and who had been classified as substandard or below” (He 2004). Although the KAMCO Act of 1997 provides that “any financial institution may entrust [KAMCO] with the disposal of nonperforming assets” (KAMCO Act 1997), the agency would “analyze whether the loans were eligible for purchase” and “conduct due diligence on the loans” before entering an “assignment and assumption agreement” and making a payment to the seller (He 2004; Cerruti and Neyens 2016).

Assets were divided into four categories: “ordinary” loans of companies still operating; “special loans” of companies in a court-supervised receivership; “Daewoo loans,” acquired mostly in 2000 after the Daewoo Group collapsed; and “work-out loans” to companies in out-of-court work-out programs (He 2004). KAMCO factored these distinctions into its pricing of NPL purchases. For ordinary and special loans that were secured by collateral, KAMCO offered a fixed percentage of the collateral value, initially 70–75%. KAMCO initially purchased unsecured NPLs at a large discount of 80% or more to face value. In September 1998, KAMCO tightened its pricing framework to 45% of the collateral value for secured loans and increased the discount on face value for ordinary unsecured loans to 97%. Work-out loans represented only 2.5% (as a fraction of face value) of assets purchased and did not follow the same pricing formula. Daewoo loans represented nearly one-third of total purchases (He 2004). See Figure 1 for further details. KAMCO treated them separately, as part of the government’s strategy to stabilize the financial system after the Daewoo conglomerate failed. The government directed KAMCO to purchase Daewoo bonds held by foreign creditors and domestic investment trust companies to “facilitate a speedier out-of-court restructuring process for these loans” after the collapse of Daewoo (Cerruti and Neyens 2016).

KAMCO’s purchases were funded by 4 different sources (He 2004):

1. issuance of government bonds (KRW 20.5 trillion);
2. assessments on financial institutions in proportion to their holdings of NPLs (KRW 500 billion);
3. loans from KDB (KRW 500 billion);
4. recovered funds from NPL resolution (Cerruti and Neyens 2016).

The KAMCO Act did not impose a resolution method, giving KAMCO the liberty to adopt a number of techniques to dispose of its NPLs. During the first year, these methods included “traditional methods such as competitive auctions, collection of rescheduled repayments and recourse to the original seller” (He 2004). Later, KAMCO experimented with more innovative methods such as “bulk (pooled) sales, individual sales, and joint venture partnerships” (He 2004). Following the enactment of the 1998 Asset-Backed Securities Act, KAMCO began issuing ABS for the domestic market (He 2004).

Over the course of its operations, KAMCO acquired assets with a total face value of KRW 110.1 trillion at a total price of KRW 39.8 trillion,^FNThese figures are adopted from the IMF report, The Role of KAMCO in Resolving Nonperforming Loans in the Republic of Korea (He 2004), which breaks purchases down by year, loan category, and selling institution. KAMCO reported the total as KRW 39.2tn (KAMCO Annual Report 2013). for an average discount of 64% (He 2004). In total, the NPLs purchased amounted to 9% of financial sector assets. While most loans were purchased from banks, KAMCO also purchased loans from nonbank institutions, including investment trust companies, insurance companies, merchant banks, mutual savings, securities firms, and foreign institutions. In total, KAMCO acquired over 300,000 loan accounts (Fung et al. 2004). See Figure 2 for further detail. KAMCO’s portfolio was heavily concentrated, with “roughly 1 percent of borrowers [accounting] for 90 percent of the face value of [loans acquired]”(Cerruti and Neyens 2016). This probably reflects exposures to chaebols, which accounted for a large fraction of credit extended in the years leading up to the crisis.

KAMCO was able to resolve a large share of its NPL portfolio through foreclosures, collection or recourse and cancellation.^FNAssets resolved through recourse and cancellation were returned to the original seller after the transfer to KAMCO. This could occur upon request by KAMCO or the seller (see Key Design Decision regarding acquisition pricing). Together, assets resolved through these channels account for more than 60% of recovered funds. Beyond these traditional methods, KAMCO used a variety of innovative tools including the issuance of asset-backed securities, joint ventures, and international auctions (He 2004).

KAMCO’s ABS issuances were well received, with a total of KRW 4.2 trillion recovered. ABS were issued on 15 separate occasions between 1999 and 2001 (KAMCO’s Experience 2002). The securities were mostly intended for the domestic market (Oh 2002). The only international issuance occurred in July 2000, when KAMCO partnered with UBS and Deutsche Bank to issue ABS with a face value of $395 million for international investors. Major international investors included Japanese institutions Norinchukin Bank and Nomura Principal Finance, as well as the California-based fixed-income investment firm Western Asset Management (KAMCO’s Experience 2002).

KAMCO also entered into several successful joint ventures, accumulating KRW 1.6 trillion of recovered funds across eight deals (KAMCO’s Experience 2002). Partners included domestic and foreign financial institutions. The deals were concluded with a variety of partners, including Samsung Life Insurance and Hyundai Capital as domestic partners and Deutsche Bank, Morgan Stanley, Colony Capital, and Lehman Brothers as international partners. These partnerships, “in which KAMCO typically held a 50 percent ownership interest,” were established to extend the agency’s role as a corporate restructuring vehicle by “farming out the longer-term management and normalization of impaired assets to specialized JVs [joint ventures]” but also served as “knowledge transfer [vehicles] for KAMCO” (Cerruti and Neyens 2016; He 2004). At the same time, they provided KAMCO with an “opportunity to participate in the upside if recoveries exceeded certain levels” (Cerruti and Neyens 2016).

International auctions were similarly successful with a total of KRW 1.8 trillion recovered over seven auctions. Buyers included investment banks Goldman Sachs and Morgan Stanley, as well as Cerberus Capital Management and Lone Star Funds, two private equity funds specialized in distressed assets (KAMCO’s Experience 2002).

Last, KAMCO also utilized individual loan sales to dispose of assets. These deals were concluded with Korean companies and took the shape of M&A agreements wherein the buyer took over the managerial rights of the distressed company, as well as simple loan sales after which the buyer took over KAMCO’s position (KAMCO’s Experience 2002).

Within five years of the first purchases, KAMCO was able to liquidate a large portion of the ordinary, special, and work-out loans it acquired but maintained a large holding of Daewoo loans. The face value of assets resolved by December 2002 represented 58.6% (64.6/110.1) of the face value of assets acquired. As of April 2003, KAMCO maintained NPLs with acquisition value of KRW 12.8 trillion (KRW 44.2 trillion face value) on its balance sheet. With an acquisition value of KRW 10.4 trillion, Daewoo loans constituted by far the largest share of assets remaining on KAMCO’s balance sheet (81.2%) (He 2004). In total, KAMCO acquired Daewoo-related loans from various Daewoo affiliates, which remained unresolved at the end of the operating window (Oh 2002). In 2009, KAMCO reported that 11 former Daewoo companies had successfully completed their work-out programs leading KAMCO to recover additional funds (KAMCO 2009).

In total, KAMCO recovered KRW 30.3 trillion by the time its operating window ended in November 2002. The average resale price for loans was 14% higher than the purchase price, with an average recovery rate of 46.8% on face value. This resulted in a gross profit of KRW 3.8 trillion. However, this profit vanished after accounting for fund operating costs. With total operating costs between 1999 and 2002 amounting to KRW 7.9 trillion, the fund accumulated net losses in excess of KRW 4 trillion during its early operations, which “[would] have to be financed by a net increase in public debt and repaid by future tax revenues” (He 2004). However, KAMCO turned a profit by the time of the fund’s liquidation in 2013. As the NPL resolution fund reached its sunset date, KAMCO reached KRW 48.1 trillion in total funds recovered, exceeding the total purchase price of the NPL portfolio by KRW 8.9 trillion and removing the financial burden to the public by covering the high operating costs of its early operations (KAMCO Reports).