Indonesia's bond market has a mantra: Restructure, don't liquidate. It's faster, easier, cheaper. An S&P Global Ratings review of defaults over the past decade reveals emerging trends in how companies are restructuring, the time it takes, and the upshot for creditors.

Six insights we cover in this report include:

• Insight 1: Restructuring is more common than liquidation;
• Insight 2: Companies often prefer maturity extensions and rate reductions to debt haircuts;
• Insight 3: Principal haircuts can reach 60%;
• Insight 4: Issuers tend to avoid court proceedings;
• Insight 5: Restructuring appears easier when it involves domestic creditors; and
• Insight 6: Foreign creditors may struggle to claim their rights.

The number of defaults and debt restructurings in the Indonesia corporate sector has spiked over the past three years. The pandemic has disrupted operating conditions, the debt burden has grown, investor sentiment is volatile, and external liquidity has fallen. The amount of debt and the complexity of restructuring processes rival those of the 2008-2009 financial crisis.

Real estate, construction, and manufacturing have felt it most. Since the beginning of the pandemic, about 40% of the cases listed under the Suspension of Debt Payment Obligation at Indonesia's commercial courts have been in these sectors..

Insight 1: Restructuring Is More Common Than Liquidation

Nearly 95% of the companies in our sample restructured their debt rather than liquidated. Four notable liquidation cases in the past five years involved the following state-owned enterprises (SOEs):

• Construction company Istaka Karya PT;
• Textile company Industri Sandang Nusantara PT;
• Airline Merpati Nusantara Airlines PT; and
• Pulp and paper producer Kertas Leces PT.

Chart 1

Companies tend to resolve defaults through restructuring rather than liquidation for two reasons:

• Liquidation is longer and more unpredictable than restructuring proceedings.
• Uninterrupted business operations during restructuring often offer a higher likelihood of eventual debt repayment, even when post-default leverage remains high.

Liquidation is especially difficult in a jurisdiction with a nascent bankruptcy framework such as Indonesia.  Indonesian courts can take up to 60 days to decide to proceed with bankruptcy petitions, and the liquidation proceedings can take up to six years.

The liquidation process of Industri Sandang Nusantara and Merpati, for example, began in March 2023 and will take six years. Both companies declared bankruptcy in 2022 (but had first defaulted on their debts years before). The government only recently disbanded both SOEs and started the liquidation process in early 2023.

In contrast, petitions for an in-court restructuring can be granted within three days (when they are filed by debtors) or at most within 20 days (when they are filed by creditors). The entire in-court restructuring process lasts a maximum of 270 days. Any breach beyond the 270-day threshold will lead to debtors being declared bankrupt by the Commercial Court.

Business continuity is a large carrot.  As is the case in most jurisdictions, Indonesian borrowers can suspend their debt-servicing obligation during the restructuring process and operate their businesses as usual. By keeping businesses operational, creditors are more likely to collect debt-servicing payments over the long term, as opposed to receiving a one-off payment from asset liquidation, which often incurs a steep discount.

In-court restructuring cases in Indonesia's Commercial Court have risen to about 550-640 cases annually since 2020. This compares with about 400 cases a year in the five years prior to 2020.

At the same time, bankruptcy cases have remained at about 100-110 cases a year, on par with the pre-pandemic level. This is the likelier route of choice for foreign creditors, who may be reluctant to endure a long, cumbersome, and unpredictable liquidation process.

Insight 2: Companies Often Prefer Maturity Extensions And Rate Reductions To Debt Haircuts

During the restructuring process, Indonesian companies and their creditors must agree on broad composition plans. Some 80%-85% of the composition plans comprise maturity extension, interest rate reduction, or debt-to-equity swaps. These options often exclude any initial haircuts on the principal amount.

Table 1

Capital Structure: Sustainable vs. Unsustainable

Despite fundamental differences in capital structure, companies tend to favor longer tenors and reduced interest rates.

Category 1: Entities with high leverage but sustainable capital structure.  This was the case for property developers such as Modernland Realty Tbk. PT. Elevated debt-to-EBITDA ratios stemmed from weak earnings performance in the years prior to their restructuring transactions. Such borrowers might have defaulted on their debts due to temporary poor earnings, working capital or funding availability conditions.

Borrowers are still likely to service and repay debts if given time and accommodative interest rates. By extending tenors (and possibly reducing interest rates), lenders hope repayment will be possible when operating and funding conditions improve, limiting principal losses.

Category 2: Entities with unsustainable capital structures.  We would typically define such entities with a debt-to-EBITDA ratios in a high single digit (barring those with exceptional liquidity or highly stable cash flows) or double-digit range. It is more surprising to us that creditors and entities would often initially opt for longer maturities or interest rates reductions rather than debt reduction.

In our view, the absence of principal haircuts among borrowers whose capital structures are unsustainable means repeated restructurings are likely. By failing to address the amount legacy debt, a borrower effectively kicks the restructuring can down the road. This may solve a short-term liquidity crunch but delays the resolution of the bigger solvency problem.

Entities in the second category are likely to incur further rounds of debt restructuring if they fail to address solvency after their first default.

A few companies illustrate this argument. Construction SOE PT Waskita Karya (Persero) Tbk. first announced a restructuring plan in 2021. The plan extended the company's short-term loans and offered an interest rate reduction. However, it did not address Waskita's unsustainable capital structure.

The company's debt-to-EBITDA ratio was about 15x, with reported debt of about Indonesian rupiah (IDR) 68 trillion and reported EBITDA of IDR4.68 trillion, as of end 2021. Without any haircut to the unsustainable debts nor a significant turnaround in its ability to generate cash, Waskita eventually faced a liquidity squeeze and announced another debt service suspension in early 2023.

The lack of debt haircut as the first option may benefit Indonesian borrowers as they seek to preserve their access to capital markets or if know they might need an injection of domestic or foreign capital in the medium-term. Capital providers benefit in the short-term too because they may not need to immediately recognize loan losses or they may wait years before a liquidation is completed.

However, unsustainable debt structures generally weigh on the long-term values of a company, especially if it needs further debt to subsidize operating deficits.

Insight 3: Principal Haircuts Can Reach 60%

A sizable debt haircut is always an option for a company with solvency problems. But it is not typically the first option at the restructuring table.

In the past three years, only Garuda Indonesia (Persero) Tbk. PT has pursued a debt haircut as high as 50% of its total debts, excluding its aircraft leases.

Garuda finalized its restructuring plan in June 2022, with different restructuring terms across creditor groups. Lessors and sukuk noteholders saw a recovery rate of about 20% while secured creditors and mandatory convertible bondholders received no haircuts.

Another more implicit type of haircut occurs when companies buy back part of their outstanding loans or bonds, either as one component of a wider restructuring or ahead of mounting financial difficulties.

Notable debt buyback transactions below par value include Garuda, Modernland, and Lippo (see table 2). We could consider such capital market transactions akin to a default (see box).

The below-par purchase of these instruments suggests an implied haircut of 10%-60%.

Table 2

The capital market transactions of Modernland, Sawit Sumbermas, and Geo Energy Resources Limited met our definition of a distressed transaction: investors received less value than originally promised without adequate offsetting compensation. And we believe these companies would have faced a conventional default had they not conducted a debt buyback or subsequent exchanges.

A company most commonly initiates a bond buyback when it faces an adverse earnings cycle or an upcoming bond maturity. Weak earnings performance increases the likelihood that the company will struggle to service its debts. Reduced access to funding will intensify refinancing risks, making a default scenario more likely.

This was the case for Geo Energy. Its bond repurchase followed a tough earnings period, and a failed attempt to expand its coal reserves. It also faced a bond maturity within 12 months from when it initiated a buyback transaction.

In very rare circumstances, lenders may fully recover the principal. Bumi Resources Tbk. PT redeemed its US$1.6 billion outstanding notes and debts at par using proceeds from a rights issuance in October 2022.

However, we note that Bumi's outstanding US$1.6 billion debt as of late 2022 was the remaining of restructured debts from a distressed exchanged the company conducted in 2017, in which a 43% debt haircut was applied.

Insight 4: Some Issuers Tend To Avoid Court Proceedings

Our sample shows about half of financially troubled Indonesian borrowers pursue an out-of-court restructuring. Such restructuring requires bilateral agreements between debtors and creditors, and could last anywhere from a few weeks to several quarters. On average, we may expect the out-of-court negotiation to last four to six months.

Table 3

By negotiating directly with lenders, Indonesian borrowers aim to maintain relationships with lenders, for future access to capital markets, we believe.

The higher the concentration of financing sources the more likely borrowers will initiate out-of-court negotiations directly with their lenders. Over the past ten years some Indonesian issuers have opted for out-of-court, bilateral agreements for the restructuring of public debts, especially when they have a high share of foreign creditors such as bonds. It is generally both simpler and faster than initiating a PKPU proceeding.

In the past three years, many Indonesian developers have pursued out-of-court restructurings on their U.S. dollar notes. In 2020, real estate developer Alam Sutera Realty Tbk. PT proposed an exchange offer at par value for a total of US$485 million notes but with extended tenor and lower interest rates.

In late 2022, real estate developer Kawasan Industri Jababeka Tbk. PT made a par-for-par exchange offer for its US$300 million notes; the new notes had an extended maturity.

In both cases of Alam Sutera and Kawasan, U.S. dollar bonds accounted for about 70% of the companies' total reported debt.

Insight 5: Restructuring Appears Easier When It Involves Domestic Creditors

Restructuring at SOEs whose creditors are predominantly domestic tends to be faster, simpler, and less acrimonious. This is less the case for SOEs whose capital structures comprise both IDR-denominated and foreign currency debts.

More than a dozen of SOEs defaulted between 2019 and 2022 and debt restructuring is ongoing. Our analysis suggests that for defaulted SOEs, the location of creditors plays a more important role in the nature and timeliness of the restructuring process than the size or complexity of the SOE's balance sheet.

Table 4

As in the case of Waskita Karya (see table 4), the construction SOE completed its first restructuring in less than five months in 2021. In our view, this could be because its restructured debts were only bank loans, amounting to about IDR30 trillion as compared with the company's total reported debt of IDR67.8 trillion, as of December 2021.

Other SOEs with both domestic and foreign creditors took much longer to complete their debt restructurings. In 2019, Krakatau Steel restructured its US$2.1 billion debts--the largest restructuring deal at the time--within 400 days via a bilateral agreement with 10 domestic and foreign lenders.

Domestic financial institutions provided more than 80% of Krakatau's restructured debts. Palm oil producer PT Perkebunan Nusantara III (Persero) took 11 months to reach an agreement with its lenders and complete its debt restructuring. The state-owned plantation company reportedly signed a restructuring agreement with its domestic lenders about a month before the agreement with its offshore lenders was signed in April 2021.

Foreign lenders also faced steep haircuts on the loans to Garuda. Garuda took close to seven months to complete its restructuring agreement with domestic and foreign lenders. Holders of its US$500 million sukuk due in June 2023 were offered a recovery rate of only 20% from the sukuk's face value.

Insight 6: Foreign Creditors May Struggle To Claim Their Rights

Investors in Indonesian debt issued by offshore special purpose vehicles (SPVs) may face legal challenges during restructuring proceedings. Many Indonesian issuers raised foreign-currency bonds through SPVs, which are often domiciled in a foreign jurisdiction such as Singapore.

These SPVs raise the proceeds, lend them to operating companies onshore, and as such, generally have no direct access to the cash-generating operations in Indonesia.

Instead, SPVs rely on intercompany loans or funds for debt servicing. The presence of the cash-generating assets in Indonesia will make any restructuring proceedings dependent on Indonesian courts recognition of these foreign entities, regardless of the underlying applicable laws of the foreign-currency debt.

During the restructuring proceedings, foreign noteholders who invest in SPVs' issuance may find their debt claims and/or PKPU petitions against the SPVs' parent entities rejected due to the existence of double claims. Consequently, this limits the ability of offshore creditors to effectively participate in the restructuring process.

Anomalies in creditor status and voting rights.  Occasionally, Indonesian companies have failed to recognize lenders of their own SPVs as their creditors. In the case of PT Bakrie Telecom, the courts rejected the claims of the holders of US$380 million notes issued by the company in 2014 on the basis that the noteholders were not direct lenders to PT Bakrie Telecom. This is because the notes were issued by Bakrie Telecom's offshore SPV; and the proceeds were lent to Bakrie Telecom.

Sometimes, the voting rights of offshore investors and their trustees may be ruled invalid during the restructuring process. In 2021, about 67.4% of creditors approved the restructuring plan offered by Sri Rejeki Isman Tbk., PT (Sritex), a textile company. This is slightly above the two-thirds approval threshold required for the PKPU process.

We note that the administrator team who supervised Sritex's restructuring rejected claims from Citicorp Investment Bank (Singapore) Ltd., the trustee of US$150 million notes issued by Golden Legacy Pte. Ltd., Sritex's Singapore-registered SPV, on the basis of double claims. On the other hand, the administrator team accepted claims on the same notes submitted by Golden Legacy's subsidiary, Golden Mountain Textile and Trading Pte. Ltd.

In other cases, Indonesian courts nullified loan agreements between Indonesian companies' offshore entities and their creditors. Consider the case of Indah Kiat Pulp & Paper Tbk. PT. In 2006, the Indonesian Supreme Court invalidated US$500 million notes issued by the Netherlands-based SPV of Indah Kiat Pulp & Paper Tbk., PT. and guaranteed by Indah Kiat, and declared the notes null and void on the grounds that the defendant (including the trustee, underwriter, and security agent for the issuance of the Indah Kiat notes) committed a tort.

Willingness to pay is crucial.   Not all companies that tap foreign currency bond markets through SPVs are at risk of default. As in all emerging markets, willingness to pay plays an important role in the credit analysis in Indonesia.

The quality of governance, the record of debt servicing through an economic cycle, transparency, and disclosure therefore become crucial proxies for willingness to pay. Only those softer factors would offset the clear limitations on creditor enforceability for SPV creditors.

Exceptions To The Rule

There are exceptions to Indonesia's rule of noncompliance with cross-border insolvency. Take Indonesia-based textile producer PT Pan Brothers. Indonesian courts recognized a debt moratorium filed in Singapore by the company, only to reject a PKPU petition filed by the company's creditors in Indonesia.

The restructuring of Pan Brothers ensued in Singapore and was completed in about eight months--largely on par with the PKPU time limit.

A note of caution, however. Future restructuring proceedings may not follow that of Pan Brothers' case. Why? Indonesian laws do not recognize precedents.

Writer: Lex Hall