Published November 27, 2008

Writedown knife bleeds companies

Derivative instruments bite deep; some firms charge losses straight to shareholders' equity

By CHEW XIANG

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(SINGAPORE) For the past year, banks here have been writing off billions of dollars in assets. But as the severity of the crisis becomes ever clearer, other companies too are being forced to take hefty paper cuts to their financial assets.

At least S$300 million was written down in the quarter to September in the value of derivative instruments and holdings of securities, according to figures compiled by BT from selected companies' most recent financial statements.

The count excludes revaluation losses on property and biological assets, forex losses, as well as losses incurred since Sept 30.

'During this kind of jittery period, all these impairments will exacerbate the poor sentiment,' said Terence Wong, co-head of research at DMG & Partners.

The writedowns came in several forms. Most serious were those associated with a type of debt instrument known as convertible bonds. These were extremely popular in the last two years as they allowed a company to raise money without paying high interest rates. Investors were partly compensated by the option to convert the debt they held into shares.

But issuers have had to take hefty writedowns as the value of their shares has fallen, which has left investors' options out of the money. Property developer China New Town lost 287.3 million yuan (S$63.8 million) in the derivative portion of a 1.2 billion yuan convertible bond issue, which it realised when it repurchased the bond in September.

Environmental protection and waste recovery solution provider Sino Environment booked a loss of 104.7 million yuan on an equity swap/convertible bond deal struck with Morgan Stanley in July, while palm oil giant Wilmar International too recorded a US$37 million loss on the fair value of derivatives embedded in convertible bonds, including the accrual of interest expense on the bonds.

A couple of companies that put spare cash in more exotic derivatives were also badly burned. Contract manufacturer Venture Corp lost S$29.8 million on collateralised debt obligations (CDOs) - taking its total so far to almost S$60 million - while Singapore Airport Terminal Services wrote off a S$10 million 3.91 per cent Fortis Bank- issued credit-linked note - almost a third of its eventual net profit for the quarter.

A third form of impairment was in the value of investments or security portfolios. Such companies include property and food- and-beverage conglomerate F&N, which made a S$27.8 million provision for impairment in value of investments; and Metro Holdings, which wrote down S$9.3 million in the value of its portfolio, mostly of units in real estate investment trusts. Singapore Press Holdings (SPH), which owns this newspaper, over the year to Aug 31 took an impairment charge of S$26.7 million, mainly a writedown of the carrying amount of its investment in an associate to its estimated recoverable amount.

Besides these actual writedowns, hundreds of millions of dollars more in mark-to-market losses bypassed income statements and were charged straight to shareholders' equity.

According to accounting standards, whether mark- to-market losses are recorded on the income statement depends on how the assets are classified and whether they pass an impairment test. If no impairment is deemed necessary, the loss is simply put in a reserve and held against shareholders' funds.

That means such losses will not show up in a company's profit-and-loss statement until the assets are sold or impaired, said Ong Pang Thye, partner at KPMG LLP. 'Even though they don't impact the profit- and-loss account, it creates volatility to shareholder funds. If it's still negative for a period of time, then it may be an indicator of possible impairment,' he said.

However, losses in equity may also be a sign that companies believe these paper cuts are only temporary, said Mr Ong.

For instance, Sembcorp Marine charged a loss of S$252.4 million to its fair- value reserve in its statement of equity. The company told BT that '61 per cent relates to fair-value adjustments of quoted equity shares (mainly Cosco Corp shares); the remaining is due to mark-to-market adjustments of forward foreign exchange contract'.

SingTel also took a S$50.3 million fair-value loss on available-for-sale financial assets straight to equity, while SPH charged S$52.8 million in losses on available-for-sale financial assets to its fair-value reserve in shareholders' equity. Second Chance Properties, meanwhile, took advantage of recent amendments to FRS 39 to reclassify S$22 million of assets and charged S$9.9 million in fair-value loss directly to equity.

'We advise investors to focus on recurring income always but nowadays, in bad times, we have to focus on balance sheets and cashflow as well. Previously, people focused very much on profit and loss, which is very easily manipulated,' said DMG's Mr Wong.