By Yusuke Miyazawa, Shannon D. Harrington and Abigail Moses
Nov. 12 (Bloomberg) -- Private talks to restructure the debt of Japanese consumer lender Aiful Corp. are threatening to erode confidence in the nation’s growing $887 billion market for derivatives that lenders use to protect themselves from losses.
While an Aiful lender said the company suspended loan principal payments, holders of as much as $1.6 billion of credit-default swaps have failed to get paid. That’s because a committee of dealers and investors that determines when the contracts get triggered has declined to make a ruling because there isn’t sufficient public information to show the payments weren’t made, said people familiar with the situation, who declined to be named because the deliberations are private.
“If this drags on and continues to expose potentially significant weaknesses, there will be erosion of confidence in the product,” said J. Paul Forrester, a partner and co-head of the derivatives and structured products practice at Chicago- based law firm Mayer Brown LLP. “If there are disputes and they take a long time to resolve, people tend to question the value of the credit protection.”
At stake is a derivatives market in which outstanding contracts jumped to $887.3 billion as of June 30 from $554.2 billion a year earlier, according to Bank of Japan data. If a credit event is declared, it would lead to Japan’s first auction to settle the swaps, said Hisayoshi Nogawa, a strategist at BNP Paribas Securities Japan.
Delaying Interest
Aiful said in September it would delay interest on some of its 915 billion yen ($10 billion) debt as it negotiates with creditors. Standard & Poor’s then cut the Kyoto-based company to “selective default.”
Derivatives are contracts whose values are tied to assets including stocks, bonds, commodities and currencies, or events such as changes in interest rates or the weather. Credit-default swaps allow buyers of the contracts to demand payment from the seller if the underlying company fails to make scheduled interest or principal payments, according to standard definitions published by the International Swaps and Derivatives Association in New York.
They pay the buyer face value in exchange for the underlying debt or the cash equivalent should a borrower fail to meet its obligations. Banks, hedge funds, insurance companies and other investors use them to insure against default and to speculate on the creditworthiness of companies and countries.
Contracts protecting a net $1.36 billion of Aiful’s debt were outstanding as of Nov. 6, making it the second-most insured Japanese borrower after the government, according to New York- based Depository Trust & Clearing Corp. As much as $238 million more of Aiful’s debt is protected through credit swaps based on indexes in which the company is a member, Depository Trust data show.
Public Disclosure
Regional committees of 15 dealers and investors were formed in March to make binding decisions for most of the market on when provisions in the contracts are triggered. The committees must base their decisions on publicly available information such as regulatory filings, press releases and news articles.
Aiful, Japan’s second-largest consumer lender by assets after Promise Co., has been struggling to fund its commitments since the government imposed restrictions on lending practices and interest rates levied by consumer lenders in 2006.
The Supreme Court invalidated contracts allowing companies to charge as much as 29 percent on loans, triggering claims for refunds that forced non-bank lenders to book losses.
Aiful Losses
Run by founder and Chief Executive Officer Yoshitaka Fukuda, Aiful hasn’t sold bonds in public markets since March 2007 and reported a record first-half loss of 282.3 billion yen yesterday. The company said Sept. 18 it was seeking to delay payments on 280 billion yen of loans and started talks with the Association of Turnaround Professionals to restructure its debt through the so-called alternative dispute resolution, or ADR, process.
Six days later, S&P lowered Aiful’s counterparty ratings to “selective default,” citing temporary suspension of principal payments, “thereby breaching the terms and conditions of the original agreements.”
The company is now in negotiations with 66 creditors before an ADR meeting scheduled for Nov. 24, according to Katsuyuki Komiya, a spokesman for Aiful. A final ADR meeting will be convened on Dec. 24, the company said yesterday in a statement on its earnings.
The committee governing Japan’s swaps market, which includes Goldman Sachs Group Inc., JPMorgan Chase & Co. and Barclays Plc, was asked on Oct. 15 by a company it didn’t identify to rule that Aiful triggered the contracts by failing to pay the loans. The company making the request provided a list of loans with principal payments due from Sept. 24 to Sept. 30 that was intended as evidence, Tokyo-based Deutsche Bank AG analyst Junichi Shimizu wrote in an Oct. 20 report.
Confidential Document
After initially accepting the request, the committee reversed itself when Aiful complained to ISDA that the document was confidential, according to the people familiar with the matter. The list was removed from the committee’s Web site. Without publicly disclosed proof that Aiful delayed payment, the panel rejected the request on Oct. 19, according to the Web site and the people familiar.
“You can assume there is deferral of payment once you apply” for the ADR process, Shimizu said, “but neither Aiful nor the lenders have disclosed the detail of the deferral.”
The schedule of loan payments wasn’t “formally disclosed” by Aiful “so we can’t comment on the incident,” Komiya said.
The Oct. 19 rejection marked the third time the committee dismissed attempts by market participants to trigger the swaps.
Aozora’s Request
A request from Aozora Bank Ltd. to judge whether Aiful caused a credit event under bankruptcy provisions was dismissed Oct. 5 because of insufficient publicly available information, according to ISDA, which acts as secretary to the committees. Aiful “in fact suspended scheduled payments of loan principal to all of its lenders” on Sept. 30 according to a statement Aozora submitted to the market committee.
Another request from Aozora, which said it lent Aiful 55.3 billion yen, seeking the declaration of a credit event under restructuring rules was denied Oct. 7.
The cost of credit-default swaps on Aiful due in December plunged on speculation they may expire without being triggered.
Contracts due Dec. 20 dropped 42.5 percentage points since Oct. 15 to a mid-price of 12.5 percent upfront, according to a trader who asked not to be identified because the prices are private. The price means that the upfront cost to protect 100 million yen of Aiful debt from default fell to 12.5 million yen from 55 million yen.
“Those who asked ISDA to rule on a credit event will want to trigger the insurance as soon as possible, but it looks like things may not work out as they hope,” BNP’s Nogawa said.
Takanobu Kawano, deputy director of the financial markets division at Japan’s Financial Services Agency, declined to comment on Aiful. Masaaki Harada, an Aozora spokesman in Tokyo, said he couldn’t comment beyond the bank’s published statements.
After Aiful’s December ADR meeting, the ISDA committee may be able to rule that a restructuring event has occurred “as soon as year-end,” Nogawa said.
To contact the reporters on this story: Yusuke Miyazawa in Tokyo at ymiyazawa3@bloomberg.net; Shannon D. Harrington in New York at sharrington6@bloomberg.net; Abigail Moses in London at Amoses5@bloomberg.net
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