Malaysia: Danamodal Nasional Berhad (Danamodal)

The Malaysian government instituted a three-pronged approach to assist its ailing banking sector during the AFC. The three interventions dealt with purchasing Non-Performing Loans (NPLs), recapitalization, and debt restructuring. It included:

1. Pengurusan Danaharta Nasional Berhad (Danaharta): an asset management company that purchased and managed NPLs from banking institutions;
2. Danamodal Nasional Berhad (Danamodal): a special purpose vehicle (SPV) that injected capital into banking institutions;
3. Corporate Debt Restructuring Committee (CDRC): a debt restructuring agency that allowed borrowers and creditors to negotiate agreements and avoid legal proceedings (BNM 1998a).

Each individual program interacted with one another in various ways. For example, banks sold their NPLs to Danaharta at fair market value, resulting in substantial losses. In a healthy economic environment, these banks would be able to raise capital to make up for this shortfall through shareholders. However, due to uncertain financial conditions, there was insufficient appetite from investors. Therefore, Danamodal stepped in to recapitalize these institutions and restore capital levels. In fact, Danamodal required beneficiaries to sell their NPLs to Danaharta in order to receive capital injections, resulting in existing shareholders bearing the losses associated with these sales. Additionally, if negotiations undertaken by the CDRC could not reach a consensus, Danaharta purchased the NPLs from the dissenting institutions, which assisted the restructuring process (BNM 1998a).

Due to the overlap between programs, shown in Figure 3, the Malaysian government created a Steering Committee that coordinated the interventions of Danaharta, Danamodal, and CDRC. The Governor of the BNM chaired the Steering Committee, which met every two weeks. Its primary responsibilities included ensuring “operations of these institutions are well coordinated and complement each other, and to keep track of their progress” as well as properly sequencing interventions (BNM 1998a).

Figure 3: Malaysia’s Multi-Pronged Approach
Source: Author’s analysis based on BNM 1998a.

Danamodal was legally categorized as a limited liability company and incorporated on August 10, 1998 as a wholly owned subsidiary of BNM (BNM 1998a; Danamodal 1998a). Its governance structure reflected this ownership as its board of directors had BNM representatives as Chairman, Managing Director, and other additional members. The board also consisted of a nominee from the Ministry of Finance and private sector appointees (Danamodal 1998a).

On July 13, 1998, BNM announced the creation of an SPV to recapitalize the banking system. The press release occurred two months after the creation of Danaharta and it references the SPV as a complement to it; “as Danaharta was set up to help remove NPLs from the banking system, there is a need for us to explore other pre-emptive alternatives to recapitalise the banking system.” The approach to recapitalization included a dual objective:

1. To inject government capital, both in “core” banking institutions and in weaker institutions that BNM identified as viable;
2. To merge core and weaker banking institutions, taking advantage of its role as a strategic shareholder (BNM 1998b).

The press release outlined a number of characteristics of the SPV including structure, lifespan, financing requirements, and operation and financing arrangements. It explains that the SPV would receive seed capital from BNM, with additional funding through bond issuances, and have a finite lifespan with the goal of selling its holdings once it achieved its objectives. The maximum expected budget was RM16 billion, which would maintain a risk-weighted capital ratio (RWCR) above 9% across the banking system. In addition, BNM would leverage international consultants to construct the operating details and financing arrangements of the SPV (BNM 1998b).

Danamodal was transparent in disclosing changes in management, operations, and selection criteria. A significant number of these announcements occurred through press releases. It also issued financial statements that aligned with international accounting standards (BNM 1998a). Deloitte Touche Tomatsu, an independent and external vendor, audited these annual financial statements.

Under the “first-loss” principle, “existing shareholders were required to bear all losses prior to recapitalization.” In practice, the application of this principle required banks to mark down the value of existing shareholders investments to accurately reveal net tangible assets and sell their NPLs to Danaharta prior to receiving capital injections from Danamodal. This forced shareholders to realize the losses stemming from declining investments and NPL sales. In addition, it resulted in “equitable burden sharing” and reduced the use of public funds (BNM 1998a).

The “first-loss” principle also played an integral role in the negotiation of Definitive Agreements (DAs), which specified the terms and types of capital used in capital injections (Danamodal 1999a).

Danamodal would first inject Tier 2 subordinated debt, in the form of Exchangeable Subordinated Capital Loans (ESCL), which was converted into equity, debt, or hybrid capital through Definitive Agreements (DAs) (BNM 1998a; IMF 1999). ESCL bore an interest of 7.5% annually and had a three-month maturity, with the option for beneficiaries to extend. The temporary funds allowed for additional due diligence and negotiations prior to conversion (Danamodal 1999a).

Following this interim period, stakeholders signed DAs that outlined recapitalization amount and instruments used (including the decision whether to convert the ESCL into permanent Tier 1 and/or Tier 2 capital), pricing of instruments, investment protection, exit option, shareholder’s call option (Danamodal n.d.a). It is important to note that Danamodal used market-based valuation methods in making investment decisions (Danamodal n.d.b). The DAs varied across institutions due to the unique situation of each individual beneficiary, and time constraints required an accommodating and practical approach. Six main principles guided Danamodal’s structuring of investments: safety (application of first-loss principle), control, return, capital base, exit potential, and monitoring requirements (Danamodal n.d.a).

The three primary instruments used for capital injections by Danamodal and their characteristics are outlined in Figure 6. The different instruments allowed Danamodal to tailor injections to the issues faced by the at-risk institution. The composition of the capital injection depended “primarily on the cash flow characteristics of the instruments and the unique circumstances of the banking institutions concerned” (BNM 1998a).

Figure 6: Characteristics of Capital Used by Danamodal
Sources: Danamodal Nasional Berhad n.d.a; Danamodal 1998a, BNM 1998a.

The worst-case scenario estimated by BNM dictated a budget of RM16 billion. This funding amount would guarantee that the RWCR across all banking institutions would be at least 9% (BNM 1998a). To estimate a maximum budget the BNM conducted a preliminary, industry-wide stress test in May 1998 that examined how banking institutions performed based on a variety of parameters and assumptions. The analysis looked at institution-specific characteristics such as projected NPLs, specific provisions (property and shares), investments, and off-balance-sheet items. In addition, it included environmental factors such as interest rates (three-month Kuala Lumpur Interbank Offered Rate or KLIBOR), foreign exchange (USD/MYR exchange rate), real estate (property prices), equity markets (Kuala Lumpur Composite Index), and contagion risk from exposure to Indonesia, Thailand, Korea (Danamodal n.d.a).

The results of the stress test, shown in Figure 4, prescribed a maximum funding requirement of RM16 billion, approximately 12% of Malaysia GDP. This was broken down into two phases; the first phase would recapitalize 14 banking institutions that the BNM deemed very likely to experience solvency issues and required a total of RM12.8 billion to bolster their RWCR to greater than 9%. The second phase involved 11 institutions that the BNM felt had a lower likelihood of experiencing solvency issues. Therefore, the BNM allocated RM1.6 billion to ensure that the RWCR of these lower-risk institutions stayed above 9%. In addition, the BNM added a precautionary 10% buffer, totaling RM1.6 billion (Danamodal n.d.a). Only 10 of the 14 institutions identified in the phase-one analysis received injections, as “Bank Bumiputra Malaysia Berhad, Bank of Commerce Berhad, Perwira Affin Bank Berhad and Utama Merchant Bank Berhad…opted for their own solutions to address their capitalisation issues” (Danamodal 1999c). Improved market conditions made injections for the institutions associated with phase two unnecessary (IMF 1999).

In order to fund itself, Danamodal received RM3 billion in seed capital from BNM (Danamodal n.d.a). It then raised an additional RM7.7 billion on October 21, 1998, through the issuance of zero-coupon bonds (Danamodal n.d.c). The BNM decreased its statutory reserve requirement from 6% to 4% in conjunction with this issuance (Cook 2008; IMF 1999). It also required banks to use the additional liquid capital from the lowered requirement to buy Danamodal bonds (Cook 2008). The bonds had a nominal value of RM11 billion, five-year maturity, yield to maturity (YTM) of 7.25%, and qualified as a class-one liquid asset with zero risk-weighting for capital requirements. Additionally, Danamodal had the ability to extend the duration of the bonds, either partially or fully, by a minimum of one year and maximum of five years. The new YTM, if Danamodal triggered the maturity extension, would equal the “sum of the average YTMs of Malaysian Government Securities (MGS) of similar or closest tenor to the extension period and 50 basis points (Danamodal n.d.c). Unlike Danaharta, Danamodal’s bonds did not carry an explicit government guarantee (BNM 1998a). However, the bonds carried an implied government guarantee since Danamodal was wholly owned by BNM (IMF 1999).

Initially, 57 banking institutions subscribed to the Danamodal bond issuance and future pricing and liquidity were determined by the secondary market for Malaysian government securities, where Danamodal’s bonds regularly traded (Danamodal n.d.a; IMF 1999). On October 21, 2003, Danamodal redeemed its bonds at maturity at a nominal value of RM11 billion (BNM 2003).

Danamodal leveraged the expertise of “reputable, international financial advisors,” Goldman Sachs and Salomon Smith Barney (BNM 1998a; Danamodal n.d.a). They were selected due to their ability to:

1. Immediately provide highly trained resources, bridging the learning curve gap;
2. Supplement Danamodal’s resources needed to meet performance expectations;
3. Provide a third party objective and independent viewpoint;
4. Provide expert advice skills and methodologies to ensure an effective recapitalization process (Danamodal n.d.a).

The advisors had a number of functions, such as performing assessments and due diligence reviews (BNM 1998a). These reviews were a prerequisite to receive funds and aimed to gauge the overall health of the beneficiary as well as determine the amount of capital required (BNM 1998a; IMF 1999). Other responsibilities included the construction of an operational infrastructure along with overall policies and procedures governing capital injections (Danamodal n.d.a).

Along with BNM, Goldman Sachs, and Salomon Smith Barney, Danamodal worked to assess the long-term prospects for each institution (Danamodal n.d.b; IMF 1999). The selection process included an in-depth analysis of competitive position and financial standing of each banking institution, quantification of potential synergies to be realized through consolidation, and CAMEL (capital, assets, management, earnings, and liquidity) analysis (Danamodal 1998a). The banks that were selected as beneficiaries were identified in the first phase of stress tests and defined as very likely to experience solvency issues (Danamodal 1999c). The risk profiles of these banks were determined through the stress tests outlined in KDD 5 (Danamodal n.d.a). Of the original 14 banks identified in phase one, 10 received capital injections, while Bank Bumiputra, Bank of Commerce, Perwira Affin Bank, and Utama Merchant Bank secured alternative solutions (Danamodal 1999c). Bank Bumiputra Malaysia and Bank of Commerce were merged with government assistance outside of Danamodal; Perwira Affin Bank acquired BSN Commercial and did not require a further injection of capital; and Utama Merchant Bank was recapitalized by its shareholders. It is important to note that none of the banks identified as lower-risk institutions in the second phase received injections (IMF 1999).

Figure 5: Danamodal Recapitalization Assessment Process
Source: Danamodal n.d.a.

Danamodal appointed a minimum of two nominees to serve as Executive Director and either Chairman or Deputy Chairman on the Board of Directors of beneficiary institutions. The amount of Tier 1 Capital injected dictated additional Board representation beyond the minimum two appointees. Through its Board presence, Danamodal facilitated mergers and implemented behavioral reforms such as “sound risk management practices and credit culture, good corporate governance and higher operational efficiencies” (BNM 1998a).

The restructuring process employed by Danamodal encompassed improvements in financial analysis and capital frameworks, operations, IT, organizational structure, human resources, and the beneficiary’s business portfolio. The initial phase consisted of an internal and external situation assessment, followed by the development of a strategic plan (strategic position, operational design, IT design, etc.) and implementation plan (changes in restructuring, governance, consolidation, etc.) (Danamodal n.d.a).

Prior to receiving capital injections, beneficiaries were required to provide a comprehensive business plan and establish, in conjunction with Danamodal, “a list of comprehensive performance targets, monthly reporting, and swift and firm remedial actions against the banks in the event of material shortfalls in performance relative to such targets” (Danamodal n.d.b). Danamodal closely monitored these performance targets, tightening its overall approach to banking supervision. This included requiring financial statement reporting to the BNM on a quarterly, semi-annual, and yearly basis, along with weekly and monthly balance sheet disclosure. The BNM also deployed CAMEL-based supervision, which focused on capital adequacy, asset quality, and management, regarding both in-person assessments, which were increased to a minimum of once per year for all banks, and external monitoring. Additional supervisory changes included BNM approval of financial statements prior to public disclosure and creation of “prompt corrective measures” which created pre-agreed responses by bank managers and owners to breaches of regulatory levels (IMF 1999).

Many of the indicators that were assessed are outlined in Figure 7.

Figure 7: Major Performance Indicators
Source: Danamodal n.d.a.

At inception, BNM predicted that the recapitalization process would take no more than five years. This timeframe would allow Danamodal to accomplish its short and medium-term objectives and make significant headway towards the long-term goal of industry consolidation and restructuring (Danamodal n.d.a). It is important to note that Danamodal expected the majority of capital injections to occur during the first two years (Danamodal n.d.b). Danamodal’s exit strategy followed the below principles:

1. Seize the earliest chance to exit;
2. Achieve objectives of recapitalization or enhance prospects of future achievement;
3. Aim for full recovery of investments;
4. If the overall economic recovery helps to restore solvency issues among banking institutions, the need for Danamodal’s continued involvement may be reduced;
5. Adhere to the overall policies views of the Malaysian government and BNM regarding the timing of the exit (Danamodal n.d.a).

On October 31, 2003, approximately five years after its creation, Danamodal closed its operations (BNM 2003). It exited the scheme through “initial public offering, strategic sales of its holdings, and sales of its holdings directly in the market” (Danamodal n.d.b).