These are tempestuous times for Brazil's banking system. Over the past few months, the government has agreed an $8 billion rescue package for one institution and a $7.5 billion bail-out for another, while a yawning hole the size of several Barings/Daiwa scandals mysteriously surfaced where the assets of a third bank ought to have been.
These are the latest and most dramatic cases in a series of banking catastrophes that have seen at least five of the country's top banks run into serious trouble and 100 financial institutions placed under central bank administration since mid-1994. And yet most analysts still maintain the banking system as a whole remains fairly solid.
"I think there is no risk of a crisis of the system," says Paulo Miguel, international analyst with Banco Inter-Atlantico, a private Brazilian investment bank. "The huge retail banks such as Bradesco, Real, Unibanco and Itau have a very solid position and a good balance-sheet structure," he says.
But, virtually in the same breath, Miguel speaks disparagingly of the appalling quality of banking supervision that failed to detect $5.6 billion-worth of forged assets on the books of the collapsed Banco Nacional, once Brazil's seventh largest private bank. That fraud, which appears to have been perpetrated over 10 years in order to maintain balance-sheet equilibrium, was uncovered only in February, thanks to the probing of journalists working for the local Veja magazine.
Miguel blames the central bank for not finding out before it approved Nacional's merger with former rival Unibanco. To add insult to injury, that merger was supported with a $5 billion credit line from the official Proer financial restructuring programme.
Adriana Lacombe, a Sao Paulo-based banking analyst with ING Barings, agrees that supervision is lax. "The credibility of the Brazilian banking system has been hurt," she says in a report. "It remains to be explained how neither the central bank nor the auditors realized that one-third of Nacional assets never existed."
This is not the only example that concerns Lacombe. How, she asks, has Sao Paulo state bank Banespa managed to avoid publishing financial statements since November 1994, even though it is traded on the stock exchange? Who is protecting the interests of minority shareholders?
Lacombe also wonders how Banco do Brasil, the government-controlled bank that recently reported 1995 losses of $4.2 billion, can get away with accounting for the Brazilian sovereign debt held by its foreign branches at face value when the market value is only 50%.
Both Banespa and Banco do Brasil have recently won approval for huge government-led capital injections. Banespa, like many other Brazilian institutions, had run into trouble when the easy money it gained through speculation in the high inflationary days vanished overnight. Its woes were doubled when in mid-1995 the government - fearing that runaway consumer spending could revive inflation - pushed up interest rates, forcing many companies into default.
There was pressure for the government to seize the moment and privatize Banespa, a bank riddled with inefficiencies and with a history of political manipulation. But Sao Paulo governor Mario Covas successfully stifled privatization talk, and instead negotiated a complex restructuring programme with Brasilia. The federal government will lend the Sao Paulo state $7.5 billion to help it refinance half its $15 billion debt to Banespa, while the other half will be paid for by transferring to Banespa's books, airports, railways and other state assets.
In the case of Banco do Brasil, whose recent $4.2 billion annual loss was the largest in the country's corporate history, analysts believes the $8 billion rescue package is better conceived. "The treasury said it wouldn't be a bail-out. It would be a strict underwriting and the private sector would contribute," says one Sao Paulo-based economist. "But let's see how it works out in practice. It's a long process."
The government is to provide $4.9 billion of that capital injection by buying new shares due to be issued by Banco do Brasil in May. The price of those shares, which will increase the government's stake from its current 51%, has not been fixed yet. The rest of the cash is due to come from existing shareholders, while there are rumours that the national development bank, BNDES, will put in $1.2 billion.
"The solution to the state-owned banks' problems is being addressed by the central bank without causing any major trauma to the financial system," says Lacombe. "But the cost of restructuring is still unknown."
Unknown, too, is precisely how the central bank could have failed to spot fraud at Banco Nacional. And that mystery may never be fully resolved, because in March the government successfully headed off opposition demands for an investigation. But the costs of this could be high. Serious doubts must remain about the capacity of the central bank to supervise the financial system. As one analyst asked: "If officials failed to notice a hole the size of four Barings, what other awful things might be lurking out there?" David Pilling
Israel
Privatization fails to take off
When the new Labour-led government took control of Israel's parliament in June 1992, finance minister Avraham Shochat declared that the government would reduce its ownership in the economy from 20% to 12%. Although it came nowhere near hitting that target the government's term is ending on a high note for the investment community. The recent share offering in London and Tel Aviv of Israel Discount Bank (IDB), Israel's third largest bank, was the government's first attempt at selling off a state-owned enterprise on London's financial markets.
The flotation valued the bank at more than £500 million ($750 million). The offering was deliberately priced below book value to make sure it succeeded in tough market conditions. According to David Cohen, a director of Société Générale, one of the investment banks which handled the deal: "The bank is conservatively financed, so it has immense loan growth potential."
Gavin Rabinowitz, head of the investment banking division at the London law firm of Nabarro Nathanson, believes that Israeli banks could represent fine, long-term investment opportunities because they have large stakes in many Israeli companies. That potential is attracting the attention of many fund managers. Michael Power of Baring Asset Management sees Israel competing for the attention of global fund managers, who are now asking: "Do I spend on Israel or Indonesia, Turkey, or Poland?"
Because of the success of IDB, UK investors will be looking closely at the next offering, the Bank Mizrachi, which is Israel's fourth largest bank and said to be worth $750 million. The government intends to sell 25%, bringing its holding down to 46%. UK-based NatWest Markets has been appointed by the Israeli government to distribute shares overseas; more than 40% of the total issue will be distributed to European institutional investors.
Despite the optimism in the UK, however, Israeli analysts are much more cautious about the country's privatization efforts. Other than IDB the Rabin-Peres government has privatized very little: a few examples are It Tahal, a water planning company for $14 million, and Lapidot, an oil exploration firm for $50 million to Swiss-based millionaire Bruce Rappaport. A few other firms, such as the retail chain store Shekem, Jerusalem Economic Corporation and Israel Shipyards were sold - behind closed doors, with no open tenders - for what many analysts claimed were below-market values.
The most valued asset (and biggest failure) is Israel Chemicals. The original plan to sell 50% to a strategic investor was scuttled by its management in favour of selling the major equity portion on public markets and a smaller stake (15%) to a strategic investor. Of the company's shares 20% have been sold on the Tel Aviv Stock Exchange (TASE). The government has pledged to sell a third of the remaining 80% of the shares for $350 million, although it still hasn't decided where or when. In February the ministry of finance cancelled an IPO on the New York stock market, at the last moment, after it became clear that the market was not prepared to pay the price the treasury was seeking.
The privatization of El-Al Israel Airlines has never been taken seriously by the Israeli government, although it has been valued at nearly $800 million. The company recently decided to delay its Nasdaq offering because of lack of investor interest.
A similar fate is in prospect for Bezek, the publicly-owned telecommunications company which sold 25% of its shares on the TASE three years ago. In 1994 the government decided to auction off an additional 25% of Bezek's shares, and wanted either Southwestern Bell or Northern Telecom to acquire a controlling interest in the company. After negotiations with these two firms broke off, an IPO in the US was decided upon. However, in late March, Tamar Ben David, the head of the Government Companies Authority (the branch of the finance ministry responsible for privatizing Israeli state-owned firms), put a stop on all negotiations with the US underwriter, Merrill Lynch, and the adviser on the sale, Morgan Stanley. Ben David believes it is unlikely that the sale will be completed this year.
Merrill Lynch wanted to issue Bezek's shares at 25% less than their value on the TASE. Yitzhak Kaul, Bezek's managing director, points out that the company was recently awarded a $260 million loan from an international consortium of banks.
"This was nearly double what we originally planned to borrow," he says. "The confidence these banks have in Bezek will be reflected by investors in the company's first international IPO - if and when that ever happens."
Ben David blames Cable and Wireless for the delay. The British company owns 10.02% of Bezek's shares, and the Israeli government had requested C&W not to acquire any more which would give it a substantial interest. However, C&W has not given the Israeli government any such commitment, and company executives have indicated it may even try to acquire up to 20% of Bezek's shares.
Meanwhile, the Knesset, the Israeli parliament, is seeking to pass a bill which would require any company that acquires more than 5% of the stock of a government-owned enterprise to get permission to do so from the ministry of finance. The bill would also require any company that owned 5% of the shares of a state-owned company (as of January 1 1996), to get government permission to acquire more shares, otherwise it would be forced to sell these additional holdings.
Many analysts claim that, despite the lip service paid over the years to the concept, Israel has not done much privatizing. This trend is expected to continue, because the economy is over-politicized and harbours too many vested interests . Joel Bainerman
Hong Kong
In the image of Fannie Mae
Hong Kong has upped the ante in its bid to retain the title of Asia's leading financial centre. In April the Hong Kong Monetary Authority (HKMA) announced the setting up of a mortgage corporation in the mould of Fannie Mae. By doing so, the colony's de facto central bank is seeking to bring to life the moribund mortgage-backed securities market and also to enhance the size and reputation of the local debt markets.
The initiative was sparked in February by the HKMA's consultations with Fannie Mae on the viability of a Hong Kong equivalent, and the move may also have a hidden agenda. Two months previously, arch rival Singapore stole a march on the territory when it became home for the prestigious financial guarantee company Asian Securitization & Infrastructure Assurance (ASIA). The Asian Development Bank, a founding shareholder in ASIA, opted for Singapore ahead of Hong Kong largely because of fears over the latter's stability following its reversion to Chinese sovereignty in 1997.
"Singapore's charm offensive to woo financial institutions away from Hong Kong has had considerable success in the past year," says the treasurer of one Hong Kong bank.
However, judging by the mixed reaction of many local bankers, the HKMA will have an uphill struggle selling the concept of a mortgage corporation. "It's probably good for the market because it should provide a standardized mortgage-backed security as opposed to the array of disparate instruments that we have seen to date," says John Lim, managing director of Asian capital markets at Chase Manhattan Asia in Hong Kong. "But a lot of local banks are opposed to the concept. For many, mortgage-related lending is both a core activity and their most profitable source of earnings. They see no need for a mortgage corporation of the sort being discussed."
Others were critical of the HKMA's plan to operate the mortgage corporation as a wholly-owned government subsidiary. "Hong Kong works well as a financial centre because it lets market forces dictate," says the director of retail banking at one local bank. "But the HKMA is creating a false market, in the sense that banks have no desire to sell on mortgage loans at present. If it effectively obliges banks to do so in return for a paltry 20 basis points in operating fees, then it's depriving them of income."
The HKMA is quick to counter its critics. "Mortgage lending is the bread-and-butter business of a lot of banks and they regard it as very profitable and low risk," says spokesman Albert Chen. "But there are guidelines in place which restrict banks' property-related lending to 40% of their total loan portfolios. And we predict that there will be a shortfall between future residential mortgage demand and supply that will grow to HK$778 billion ($101 billion) by the year 2005. This means that a point will be reached where banks that hit the 40% guideline will not be able to go after further mortgage business. This, in turn, suggests that there is very much a need in Hong Kong for an intermediate agency."
His detractors are not persuaded. "First off, there is no reason why banks which reach the limit cannot securitize their own mortgages for sale to investors," says the director of retail banking. "The HKMA is also off the mark in that it classes all mortgage lending as directly related to property, whereas in Hong Kong residential mortgages tend to reflect more an exposure to the economy as a whole and are related to household income levels. Delinquency rates on such mortgages here have traditionally been very low, anyway; they were much less than 5% even during the early 1980s property crash."
Capital markets practitioners are much happier with the initiative. "It's a very welcome move because it should provide another high-quality issuer in the local Hong Kong dollar bond markets," says Patrick Thomas, managing director of Oakreed Financial Services in Hong Kong. "The government's backing of the corporation will ensure that it has tremendous psychological support in the market."
Philip Li, director of capital markets at the Industrial Bank of Japan, adds: "The mortgage corporation should go a long way to solving both the credit enhancement and liquidity problems that the mortgage-backed securities market has traditionally faced in Hong Kong. It should also enable the many foreign banks which want to enter the Hong Kong mortgage sector to acquire high-yield assets without the large operational costs of establishing a retail business."
And lest any should worry that Hong Kong's regulators do not have an eye for the main chance, Chen assures that the proposed mortgage corporation will be "a very profitable institution". Capitalized at HK$1 billion from the colony's Exchange Fund, and incorporated under the Companies Ordinance, it forecasts a return on equity of 20%, based on the conservative assumption that the geared-up HK$20 billion mortgage loan portfolio it envisages will earn a profit margin of 1%. There are also plans to attract private capital at a later stage, and a listing on the Hong Kong Stock Exchange is being considered. Tony Shale
Ghana
Rich pickings or fool's gold?
The international funding activities of Ashanti Goldfields have had a positive impact on the Ghana Stock Exchange. The presence in world markets of a Ghanaian company with a rock-solid reputation has awakened investors to the potential of its home base.
But one fund manager sounds a cautionary note. "Investors should look for a return over five to 10 years," says John Legat of GT Unit Trust's Africa Fund. Despite its high profile and strong image relative to other African exchanges, the Ghana Stock Exchange suffers from all the classic emerging market problems: too few stocks, poor liquidity, slow settlement (two weeks), antiquated systems and a lack of local investor interest.
"What we need most to energize the market is a quick and efficient delivery-versus-payment system," says Francis Tweneboa, the exchange's general manager, "and the listing procedure for companies on the exchange is cumbersome. There has been no major review of the Companies Act since legislation was passed in 1963."
The market also has to become more than just a trading post for Ashanti's shares, helpful as the strong ties with Ghana's number one company have proven. Ashanti makes up more than 90% of a total market capitalization of over $2 billion.
The listing in London last year, and the SEC registration of its $250 million convertible bond in February (listed in New York), diversified the company's investor base. According to Susan Lewis, assistant director of equity capital markets at BZW, which with Goldman Sachs launched the issue: "The proceeds were in part to repay the acquisition funding for Cluff Resources and for future expansion."
Fund managers say the offerings raised the standing of the company and, at the same time, encouraged nascent Africa funds to examine the potential of Ghana. Their perception is that the country is taking one more step towards integration into the global economy. This may be true although investors with direct experience of working in Accra, and coping with the exchange's shortcomings, have a more jaundiced view.
However, they are cautiously optimistic about a $2 million World Bank loan to raise the exchange to international standards. A key component will be the establishment of a securities regulator independent of the Bank of Ghana. From the outset, multilateral institutions have played an important role in assisting the exchange, which started floor trading in November 1990. At that time Cooper's & Lybrand was brought in by the IFC to establish a market framework.
The Ghana Stock Exchange has 12 licensed broking firms with 11 actively trading. One, SDC Brokerage Services, is part of Securities Discount Company Investments, which was subject to a devestating report early in April by Bill Whitworth, a former managing director of Ecobank. Whitworth declared that it was a "company out of control and drifting toward catastrophe", and concluded that disastrous loans and poor management meant the bank was insolvent. SDC's non-executive chairman, Afare Donkor, was forced to resign one of his other jobs, that of stock exchange chairman.
From the 11 other broking firms, 32 people now work on the bourse . According to Tweneboa all are university graduates and some have professional qualifications in accountancy or banking. Five course modules designed by Cooper's & Lybrand, as well as exposure to foreign stock markets, push them further up the learning curve, says Tweneboa.
Trading happens three times a week at 10 o'clock by a call-over system. Brokers sit around a table and take turns to make offers or bids as each stock is announced. They can adjust their prices during a second round of calling, after which deals are matched and recorded on computer.
One challenge is to make portfolio investment attractive, and Tweneboa is encouraged by measures such as the ending of triple taxation on dividends paid to individuals who hold company shares through unit trusts. Much more needs to be done, he argues, to create a level playing field with direct investment in unlisted companies.
"We need to build an infrastructure that is non-discriminatory," he says. For the time being listed companies are protected from foreign takeover by a 74% limit on non-resident holdings and a 10% individual restriction. Another problem which restricts liquidity, points out Ken Ofori-Atta, chairman of Databank Brokerage, is that multinationals hold around 50% to 60% of their own shares.
Foreign portfolio investment is made easier by Barclays Bank which has been in Ghana since 1917. Through Barclays Global Securities Service, the bank has provided custodial services since 1994. Without access to secure custody arrangements, international investors would stay away.
However, the golden rule in emerging markets is that foreign investment doesn't start to flow until local buying takes off. This is a problem in Ghana. Demonetization of the C50 note and freezing of bank accounts above C50,000, 15 years ago after Rawling's second coup, hasn't been forgotten. Spare cash tends to go into real assets, especially residential property.
The World Bank estimates that 45% of private sector savings are mobilized through informal channels. In particular, itinerant bankers called susu collectors visit shops and markets daily and receive funds for savings plans.
Databank's Ofori-Atta, agrees that it is crucial to "change the Ghanaian cultural perception of what shares are; that is, a great way of saving". It is also important to accelerate the privatization programme, and continue to provide incentives for investors, he says. The abolition of stamp duty two years ago, and a capital gains tax holiday until 2000 has helped. But the slow pace of privatization and the restricted supply of new tradeable securities means the stock market's momentum has stalled. Only a third of the 260 state-owned enterprises have been divested since privatization began in 1988, and there is still little prospect that four behemoths - Ghana Telecom, State Insurance Corporation, Ghana Oil Corporation and State Housing Corporation - will be divested soon. Rupert Gordon-Walker
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