Editorial: Korean rescue is only a start
On December 22, William McDonough, chairman of the Federal Reserve Bank of New York, summoned the heads of the six biggest banks in the US to a meeting in his fortress-like Federal Reserve building on Liberty Street. With the holidays looming, not all the banks were able to send their chairmen. But it was a pretty high powered group that assembled some hours later: JP Morgan chairman Douglas Warner; William Harrison, vice-chairman of Chase; George Vojta, vice-chairman of Bankers Trust; J Carter Bacot, chairman of Bank of New York; Richard Bloom, senior vice-president at Bank of America; and Alan McDonald, executive vice-president of Citibank. On the agenda was Korea.
The bankers attending that first meeting didn’t talk much. They listened. The news was grim. Korea was bleeding more than $1 billion a day in liquidity and hard-currency reserves were below $6 billion. The banks were urged to maintain credit lines to Korea. They were told that it was in their own interest to maintain lines. They were warned that a debt moratorium in Korea would pose a systemic risk to the world financial system because of the high exposure of Japanese banks to Korea. For the first time, bankers heard the phrases “IMF plus” and “second line of defence”. The G7 countries and the IMF, fearing the consequences of the collapse of an OECD country, one of the largest economies, were preparing to put more public money into Korea. But the US treasury and other governments had a pressing concern. They could not pour taxpayers’ money in through the front door to Korea just to see it flow immediately out of the back door to pay off loans to international commercial banks. For an IMF plus programme to come into effect, commercial banks would have to agree to roll over their credit lines to Korea and accept some of the consequences for imprudent overlending at short-term maturities.
The bankers went back to their offices to discuss what to do next and to call their people in Korea. Most wondered what was the minimum they could do to stave off disaster. The Fed kept up the pressure. On the evening of the following day, Tuesday, it called the banks again and asked them to send representatives to a second meeting on December 24, Christmas Eve. This time, Chase chairman Walter Shipley attended. Managing director Ernest Stern accompanied Warner from JP Morgan. McDonough repeated the official view that the banks should agree to roll over their lines of credit. The banks agreed. The first and most important step had been taken to avert financial meltdown in Korea.
Why was it taken in New York? The US treasury had been the driving force, pushing the private-sector banks to resolve their position over Korean short-term debts in a way that would allow the IMF plus plan to work. It was also convenient to meet in the same time zone as the headquarters of the IMF which became an important clearing house for up-to-date information and statistics on Korea. Furthermore, US banks have a long history of leadership in sovereign-debt negotiations, dating from the Latin American debt crisis of the early 1980s. One US public official sums it up: “It wasn’t a question of the Americans wresting control over a process from someone else. Nobody else was doing it. The US was the first to hold its bank meeting and thereafter it became evident that the intellectual leadership in all of this was going to come from the US.”
By now, other countries’ central banks and private-sector institutions were swinging into action at varying speeds. On Christmas Eve the Bank of England had called the chairmen of the leading UK banks and it was agreed that HSBC would act as country coordinator. HSBC Holdings group general manager Bert McPhee, a veteran of such infamous corporate debt work-outs as Eurotunnel and Olympia & York, was named point-man in the negotiations. The UK banks developed an agreed UK position as to what debt should be rolled over and to what date. This was transmitted to McPhee before he went into a meeting at JP Morgan’s headquarters in New York scheduled for December 29. The UK banks’ position was that they would roll over short-term bank debt to March 31, but only as long as everyone else agreed to do the same.
The German banks had been a little slower. There were many more German than British banks lending to Korea and coordination was difficult. Senior credit officers at some German banks had travelled to Seoul for December 22, having heard rumours that three or four major foreign banks had initiated discussions there on the liquidity problem. These came to nothing. Back in Frankfurt on December 23, the banks started taking calls from the German finance ministry. But it was not until the 29th that they convened a meeting at the headquarters of Deutsche Bank in Frankfurt, where banks were met by officials from the ministry and the Bundesbank.
On December 29, the German banks agreed to roll over credits falling due by the end of 1997 for an extra month, in contrast to the UK and certain US banks whose position was to roll over for three months, to allow time for a more comprehensive rescheduling.
Order out of chaos
This was still a chaotic time. Different banks were agreeing to roll over lines for differing lengths of time, some for just days or weeks rather than one or three months. The whole point of the meetings on December 29 had been first to secure the roll-over of debts falling due at the year-end, before tackling the credits falling due in the first quarter of 1998.
In New York, to bring some order to the process, roles were now assigned. On the American side, Chase would coordinate with smaller banks around the US; JP Morgan would work up a plan for the second stage of the process – avoiding a crisis in payments of debt falling due early in 1998 and raising new money – and Citicorp would work with the international banking community.
William Rhodes, vice-chairman of Citicorp and veteran of the Latin American debt negotiations, had finally managed to hitch a plane ride back to New York from Barbados. He worked hard over the weekend from Friday evening, December 26, on his first task, which was to open channels to the Japanese banks, the group with the largest exposure to Korea and yet among the slowest to coordinate their own response. The Japanese were to be represented in New York at the December 29 meeting by a delegation from Bank of Tokyo-Mitsubishi. Their position was hard to read, especially given their own funding problems. Their domestic bad debts were growing and their capital was being eroded with the fall of the Nikkei. In negotiations on credit lines to a troubled borrower, no bank wants to be the only lender rolling over. The other international banks would only finally agree to roll over their own exposures if they could be confident the Japanese – the biggest lenders – would do so as well. It was vital to get the Japanese on board.
At this point, Rhodes’s tremendous personal contacts across the banking world, and his stature as a vice-chairman of Citibank and as grandfather of previous debt negotiations, held the process together. He and his colleagues contacted the chairman, vice-chairman or president of each of the top 10 banks in Japan, at the same time talking to Japanese vice-minister of finance Eisuke Sakakibara.
An agreement was close, but one group had to be tied down first in order for everyone else to agree. Rhodes recalls: “I had to assure the Japanese that they would not be the only ones to roll. I put my word on the line.” He managed to convince the Japanese banks to roll over lines falling due at the year-end until at least Monday, January 5. He had bought some breathing space.
“Then,” continues Rhodes, “I spoke to a number of Europeans and Canadians and they agreed to roll.” On the Monday morning meeting at JP Morgan, Rhodes took the chair and all the parties confirmed they would roll over their lines, though for varying periods. “We had to get them to agree just to do it. And then establish some rules later,” says Rhodes.
But Rhodes and Citibank were not the only ones who had been busy over Christmas. At the December 29 meeting, JP Morgan unveiled its plan for a longer-term solution to Korea’s liquidity crisis.
The Morgan plan, sometimes also called the integrated approach, took negotiations to a new level. It was bold, imaginative and controversial. It was useful at least as a first attempt to reschedule Korean bank debt falling due in the first half of 1998. “It gave people something to focus on. It was very creative,” says one observer who sat in on all the talks. “It got people’s focus off the past, off the hysteria and panic and got them onto the question of ‘what should we do now?'”
It also drew attention to the numbers involved. “The JP Morgan plan said big bucks,” says Bloom. “It said that banks would have to think about restructuring loans coming due not just in the first quarter but the entire first half.” JP Morgan was suggesting a $25 billion programme, combining an exchange by foreign creditors of $15 billion of short-term debts of Korean banks for new Korean government bonds of varying medium- to long-term maturities and in addition $10 billion of new money to be raised simultaneously through an offering of additional Korean sovereign bonds.
The logic of the Morgan plan was that, since this was always supposed to be a voluntary initiative of the international banks, the pricing on extended and new commitments should be at market levels. Market levels in turn suggested a capital-markets exercise, with creditors offering to take Korean debt at whatever price they could stomach. Morgan suggested that pricing on the deal would be determined through a Dutch-auction process, with international institutions bidding to convert their outstanding loans and buy new bonds, with the lowest bid that cleared the full $25 billion amount prevailing.
A giant gamble
Some bankers saw the plan as “one roll of the dice”, linking, in one giant gamble on the openness of the international bond markets, the refinancing of existing loans and the raising of new money. Stern explains: “This was intended to be a voluntary, market-driven operation and we thought there would be advantages to including an option for converting debt into bonds, in addition to converting bank debt into new government-guaranteed, loans.”
But Korea was about to undergo a change of government. The new government would have to bless such a huge capital-markets exercise which would affect the terms of Korea’s financing and its whole economy for years to come. And the new government would have to do this before officially assuming power.
The Federal Reserve had asked five major investment banks to attend this meeting and sign the subsequent statement on short-term credit renewals. For the investment banks this was a token effort: since they had no huge loan exposures, although they may have had some bond inventory and, more significantly, swap exposure to Korean bank counterparties. But they were invited because this was not meant to be exclusively a commercial-bank show. Some banks had grumbled that they were being picked on, and that by urging them to roll over loans, the Fed, and by extension the treasury, were imposing a kind of tax on commercial banks.
The unveiling of the Morgan plan aroused some tension between the two groups. Goldman Sachs and Salomon Brothers had both been appointed financial advisers to the Korean government on December 15 and were working on ways to bring Korea back to the bond markets. When they were appointed, Korea had not been downgraded to junk-bond status and a bond deal was theoretically possible and even desirable. Was Morgan now proposing that it should lead a jumbo $10 billion bond deal and scoop the fees that Goldman and Salomon had their eyes on?
This wasn’t the case. The downgrades Korea had suffered in the days before Christmas had changed things dramatically. “There was no way on god’s green earth that a bond deal could have been done at this time,” says an adviser to the Korean government. One of the mandate-hunters concurs: “There was no conflict. It was very much in our interests that the banks successfully complete their negotiations over short-term debt.” But the Goldman/Salomon team had strongly advised the Koreans first to address the issue of short-term bank loans and only then attempt to re-enter the capital markets. Their advice, and the Koreans’ own idea, was to break the Morgan proposal into at least two steps.
At the meeting on December 29, Morgan had pushed the idea of rolling over only the loans falling due at year-end 1997 until January 31, as a way of keeping the Koreans’ feet to the fire and pressuring them to accept the plan. It was a tactic neither the Koreans nor many of the other banks welcomed because a one-month roll-over would have maintained the very atmosphere of impending crisis Korea and its lenders needed to dispel.
Rhodes suggested, contrary to Morgan’s idea, that the initial roll-over of loans be until the end of the first quarter of 1998. “Based on my experience, that was the minimum amount of time needed to roll out the 1998 maturities to some sort of medium-term deal.” Other bankers agreed and from that time, Rhodes emerged as clear first among equals on the international banking side. David Pflug, senior credit officer at Chase, had suggested at this meeting that Rhodes should take the chair. Many subsequent meetings took place at Citibank’s head office on Park Avenue.
The commercial banks were divided over most aspects of the Morgan plan which came to be redrafted several times in early January. Some changes were relatively unimportant. The original proposal had included derivatives positions to be among the debts eligible for exchange into Korean government bonds. Bankers and public officials in the west at first worried that these might constitute an enormous black hole. “But as it turned out, the Korean banks did not have huge off-balance-sheet exposures,” says Pflug. After IMF figures revealed this, most bankers were then happy to drop off-balance-sheet items.
Trading imperatives
Other decisions were reached quickly. For some reason the US treasury had wanted to include trade credits in the list of exposures to be rescheduled. But the view prevailed that this was unnecessary and counter-productive. “An IMF programme is supposed to support a country’s currency. To re-establish equilibrium in the forex market, you also need to export and for that you need trade credit,” says Bloom. “Korea is an importing and exporting country. This is a country that needs that type of credit.” Korea needed trade lines to stay open to build up its current-account surplus and reserves. Banks themselves could take the decision whether or not to deal with Korean exporters and, in the event, they did keep trade lines open and even increased them, at rates as high as Libor plus 600 basis points for 90-day money at the worst point in the crisis.
Other questions were thornier. Some banks, particularly some of the Europeans, disliked the idea of giving up their loans to particular Korean banks and receiving homogenous government bonds in return. Their reasons for making the loans in the first place had been to cement relationships with the Korean banks which they hoped ultimately would produce profits through trade finance or other routes. “Our view from the beginning was that we wanted to keep our relationships and not change obligors,” says one German banker. “We had several meetings here in Frankfurt of the larger German creditors and we all had that same idea.”
Meanwhile the Japanese banks were desperate to have at least some form of government guarantee on their Korean loans. Korea is still an OECD sovereign and the lenient regulatory capital requirement against loans carrying such a guarantee was vital for Japanese banks whose capital position was eroding with every dip in the Nikkei.
Other aspects of the plan created unease, particularly linking the debt exchange and new money elements and the Dutch auction mechanism for establishing pricing. Most bankers reasoned that such a mechanism would produce high margins on the new Korean bonds. If banks didn’t already know how much of their original loan exposure would ultimately be replaced by Korean government debt, that uncertainty would naturally induce them to bid a higher price than they would were the question of existing loans already resolved.
“The Dutch auction bothered a lot of the official sector,” recalls one banker, “and a number of banks, particularly some of the Europeans and Japanese, expressed the fear that rates might come out so high that there would be a political backlash in Korea against the whole deal.” The response of Morgan and its supporters was that this was a modified Dutch auction. Korea would not be obliged to accept the rate and by retaining the option to declare the exercise a failure could exert some pressure on international creditors to be reasonable.
In addition, Morgan wanted to establish firmly that this second step would be a truly voluntary exercise. No-one could claim that the process by which central banks had initially urged lenders to stand still on collecting short-term Korean debts had been less than coercion. The central banks had made clear that they would be monitoring the activity of banks under their charge in rolling over Korean credits.
One German banker recalls the meeting in Frankfurt on December 29: “It’s rare enough for the Bundesbank and the ministry of finance to get together and then address the banking community and make it relatively clear that something had to happen. It was made very clear to us that, if the drain from Korea continued, the last resort would be something no-one wanted to see. Then the mere fact that the Bundesbank said it would be monitoring roll-overs on a daily basis showed how seriously they took it.”
Prettying up the deal
Now, having set the rescue act in motion, the US treasury and other official bodies wanted to step back. Ideally, the US treasury wanted a solution that could be portrayed as entirely voluntary. “We wanted to take the next step in a public, open way that showed the Koreans were not simply relying on stuffing their relationship banks,” says one supporter of the Morgan plan. Such reasoning cut little ice even with some other banks. “Morgan was creating a creditors’ Christmas tree, a creditors’ dream, with nothing very friendly to the Koreans and pricing up in the stratosphere,” says one banker. “The notion was ‘we’ve got to market this debt and make it as attractive as possible to a wide audience’.”
While foreign bankers debated these sometimes obscure issues during early January, the Koreans were struggling to put a negotiating team together. Korea had already sought high-level outside advice, not only hiring Goldman and Salomon as financial advisers but also asking Goldman Sachs partner and former New York Fed chairman Gerald Corrigan to act as strategic adviser on reform of the banking system. On December 22, Corrigan had been asked to come to Korea by deputy prime minister Chang-Yuel Lim to advise on a complete overhaul of the institutional structure, legal underpinning and regulatory supervision of the domestic financial system. Corrigan did not intend to concentrate on the immediate negotiations with foreign banks, he merely pointed out the obvious to the Koreans: that the priority was to stop the bleeding and to do so in a way compatible with their longer-term goal of restoring the country’s financial position.
Inevitably, the Korean government sought Corrigan’s views. Corrigan gave them a practical piece of advice: get a good lawyer. He is credited with recommending Mark Walker, partner at Cleary Gottlieb, Steen & Hamilton, a veteran representative of troubled borrowers in their talks with international banks, notably Mexico. “He is still Mexico’s principal adviser and attorney even on their private deals. He is the best known of all restructuring lawyers. He’s as tough and as smart as they come,” says one banker. Walker arrived in Seoul for the first time in his life on January 5 for intensive discussions with Lim and also to meet deputy finance minister Duck-Koo Chung in his brief breaks between meetings with the IMF. He quickly became a central participant in the negotiations, a counterweight on the Korean side to Rhodes – who knows him well – and the other high-profile bankers.
In that first week of January, the Korean parliament passed approval for the government to extend $20 billion in sovereign guarantees and to issue $10 billion of bonds. Soon after, concern was expressed by the country’s legislators over the size of the deal now being suggested in New York. No-one in the Korean government wanted to go back to a hostile parliament and ask for authority to issue two and a half times the amount of government bonds that it had only just approved. Already the mood in Korea was not receptive to the detail of the Morgan plan.
Korea’s domestic political scene provided a troubling back-drop to the financial crisis. A new president had been elected but would not take office until February 25. Until then the defeated government remained nominally in charge. It was far from clear which officials would take what key economic and financial posts in the new administration. The foreign banks were anxious to negotiate a deal that the new government would adhere to.
A respected foe
Walker had returned to New York on January 8 for informal meetings with certain bankers. Many of them greeted him with mixed feelings: he has been their foe in many hard negotiations but at least he’s a foe who speaks their language. “The great thing about Walker is that he can explain to a difficult client exactly what cards they do hold in their hands and what cards they don’t,” says one banker. Another says: “If the need ever arose I’d want him to represent me.”
Walker assured the banks that, whatever came out of their discussions, it would be a negotiated solution. This implied negotiated pricing, rather than the market-driven pricing envisioned in the Morgan plan, which was then still very much on the table. The word “negotiated” drew a strong reaction from Morgan. Another banker decided this was the time to give Walker some needle. “Mr Walker,” he said quietly, “there are now several major financial institutions advising the Koreans [a reference to Goldman, Salomon and Corrigan] can we be sure you are also someone we should be dealing with?” Walker didn’t flinch, but equally quietly confirmed that he had been retained by the Korean government.
Back in Korea, the importance of putting up one negotiating team for both present and future governments had been realized. When Walker returned to Korea for a second visit – he drafted a first set of Korean proposals during the flight, referring to Morgan’s paper, among other documents – he met representatives of the new government who now sat together with old government people on the newly formed “joint presidential committee on economic policy”.
At these meetings in Seoul during the second full week of January, a set of principles were established which the Koreans felt were essential for any final agreement. The Koreans were adamantly opposed to offering marketable securities, to auction-pricing and to linking the maturity extension and the new money. “Of critical importance to them was that the Korean banks maintain their creditor/lender relationships,” recalls Walker.
While the Korean team had been coming together in early January, the banks had been drifting apart. Many European banks had objected to the aggressive marketing of the Morgan plan and to its details. Resentment seethed among the non-US banks that the US treasury was pushing them around. “A number of continental European banks were quite beside themselves,” says one official. “So they went off and started to work on their own plan. The Japanese similarly went off and there was worry that they might be cutting a side deal. The thing was starting to fracture.”
It was Rhodes who held things together. The Koreans had recognized his importance and on January 13 deputy prime minister Lim wrote officially to Rhodes asking him to chair the negotiations due to begin in New York on January 21. Rhodes would be senior coordinator of a 13-strong group of banks the Koreans wanted to work with. As well as Citibank, these were Bank of America, Chase, Morgan, Bank of Nova Scotia, Bank of Tokyo-Mitsubishi, Sanwa Bank, Deutsche Bank, Commerzbank, WestLB, Société Générale, HSBC and SBC Warburg Dillon Read.
Walker does the rounds
The Koreans were most anxious to keep the non-US banks, their biggest creditors, on side. Walker had stopped off in Tokyo on his way to Korea to meet Japanese banks. He returned to New York via Europe to meet French and German banks. These meetings did not amount to official negotiations, but, Walker recalls, “I wanted to make sure that the banks weren’t taken by surprise by our thoughts and that we weren’t surprised by theirs”.
In Tokyo, Walker discovered how strongly the Japanese wanted to maintain relationships with original debtors. In Europe, he found that the German banks in particular had a considerable exposure to the Korean merchant banks and wanted their short-term loans to be included in the negotiations. The Koreans were reluctant. They wanted to limit the number of Korean banks that would be protected by the extension of government guarantees. The Korean government was happy to help save the country’s leading 32 commercial banks. But it had decided some of the riskier merchant banks would be allowed to fail. The Koreans worried about how the IMF and indeed the rating agencies would react if the government was seen to be assuming ever larger contingent liabilities for private-sector banks. Later, in New York, it was decided that debts of some Korean merchant banks would be eligible for exchange into government guaranteed loans.
Walker’s visit to Frankfurt was a watershed. According to one participant that was when the Europeans presented “the anti-Morgan plan”. Walker encountered a largely sympathetic audience in Europe. By this stage, he was carrying the Koreans’ draft proposals in his pocket, although he didn’t tell that to the European banks. But there was antipathy in Europe, as in Korea, for the so-called integrated approach.
Walker and the Koreans could now go into the serious negotiations in New York fully aware of the tensions among the bankers facing them across the table. The Korean team was in place. It consisted of deputy finance minister Duck-Koo Chung of the old government, and from the new government Yong-Hwan Kim, co-head of the joint economic committee and Jong-Keun You, official economic adviser to the president elect. In the absence of deputy prime minister Lim, the other co-head of the joint economic committee, it seemed that the new government was now calling the shots. Whatever the background rivalries, the Koreans at least gave the appearance of unity.
On January 19 Rhodes hosted a dinner at the Links Club in New York. He tried to steer conversation away from the forthcoming negotiations to the broader subject of Korean history. The intention was to remind the Koreans that Citibank had long-standing links with Korea and wasn’t just pushing a deal. He wanted to create a friendly atmosphere so that if things became heated later, the Koreans would know it wasn’t personal.
On the afternoon of Wednesday, January 21, the Koreans came to the boardroom at Citibank’s Park Avenue headquarters to put their proposals on the table. Certain European banks first suggested that, instead of government bonds, the Koreans should offer government guarantees on the original loans of Korean banks. It was the only alternative structure to the Morgan plan proposed by other banks and it was discussed for just over an hour. The Koreans made their own proposal. They wanted a simple exchange of commercial banks’ debts for government guaranteed loans, no new money, no government bonds, no Dutch auction and pricing by negotiation. “We didn’t tell people ‘here’s what’s wrong with the Morgan plan’,” says Walker. “We said: ‘here are our proposals.’ I can’t blame anyone for suggesting something that’s in their own interest. But we thought auction pricing for a combination of new money and maturity extensions would produce an unnaturally high number. This was an extension of bank loan maturities, not a capital markets issue.” If Korea had offered bonds which the banks could trade out of at par immediately, that would be like giving them their money back. The message implicit in the Korean proposals was that everyone was in the same mess and must share some responsibility.
Morgan continued to push its plan arguing that the Dutch auction was the best method for price discovery, but the argument didn’t last long. Morgan had limited leverage. “Everybody knew something had to be done about the maturity profile of the existing loans. So it wasn’t as if we could refuse to do the roll-over just because the Koreans wouldn’t raise new money through the Dutch auction,” says a banker who supported Morgan. The Koreans had established that – with the fine details still to be decided – the deal would be negotiated along their own principles.
The Koreans now suggested that everyone should disperse and meet the following Monday. Rhodes disagreed, arguing that all the participants should keep talking, to iron out any problems in the details of the plan. “This was a voluntary deal in which time was of the essence,” says Rhodes. “I wanted to keep the momentum going, so I insisted we all meet again on the Friday.”
It was a good decision. Problems surfaced over the handling of the Korean government guarantee. One line in the draft agreement suggested the programme should be voluntary for the Korean banks, something unthinkable for international creditors. The Europeans were also insisting on Korean merchant banks being included. The Korean team, taking advantage of the 14-hour time difference between New York and Seoul and the fact that Korean banks work on Saturdays, now had the best part of three days over the weekend to fly back to Seoul, brief the president and the president-elect and resolve these problems.
Before the Korean team left New York that Friday, Rhodes urged them not to negotiate through the press. An article had appeared stating that the Koreans were unhappy with what banks were proposing to them. The source seemed to be governor Jong-Keun You of North Cholla province, a key member of the negotiating team and also a quasi-official spokesman. It was a tough moment in what had been a tough meeting. “Are you telling me to keep my mouth shut?” You asked. Rhodes replied that it would be a good idea, at least until the negotiations were over.
The pricing question
After the parties returned to negotiations on Monday, the guarantee questions were quickly resolved. All sides now wanted to conclude negotiations by the end of January and they all knew the key issue was pricing. “I was dreading the pricing,” recalls one banker, “partly because the Koreans were so price-sensitive. It was by getting hooked on short-duration, low-margin debt that they got into this mess. And they obviously didn’t like Nick’s plan [Nick Rohatyn is JP Morgan’s head of emerging markets] because of what the Dutch auction might mean for them in margin. I got the sense that margin was everything to them.”
By now, some of the key players were leaving the scene. Stern flew to Zurich for a meeting of the Institute of International Finance, which Rhodes had also been scheduled to attend. Pflug had become tied up in Indonesia. Rhodes stayed on in New York.
Tuesday and Wednesday were tough negotiating days. Again Rhodes forced the pace, insisting the Koreans go immediately to the question of pricing and other outstanding substantive issues.
It was decided that international banks should be allowed to exchange their loans to Korean commercial and certain merchant banks for one-, two- and three-year loans carrying Korean sovereign guarantees. The banks knew that at the low point for Korea around new year, what bank lines there were still being freely rolled over attracted margins of Libor plus 500bp to 600bp. As January progressed, Korea’s current account improved strongly and it appeared to be complying closely with IMF requirements. It had opened up its bond and equity markets and some foreign money was flowing in. Reserves had improved to $12 billion – not the $30 billion to $40 billion Korea might consider adequate, but a lot more reassuring than the lowest point of $5 billion to $6 billion. The mood towards Korea improved and the free-market price for short-term roll-overs improved to around 300bp to 325bp over Libor in mid-January. Spreads on quasi-sovereign Korean bonds from issuers such as KDB and Kexim maturing in 2001 had been as volatile, moving between 50bp and 100bp in a week but trending down through the first three weeks of January from 500bp over treasuries towards 300bp over.
The Koreans were now asking for longer maturities, but conceding sovereign guarantees. Some banks hoped to get margins of 300bp to 400bp on the longer maturities. The banks also alluded to the high margins being talked about on the, as yet unseen, second line of defence public-sector money. But the Koreans rejected comparisons with spreads on thinly traded bonds and instead pointed to the very thin margins on loans extended over the prior six months to many emerging market borrowers, such as Mexico, arguably of lesser fundamental credit quality than Korea. Their proposals for pricing were in the region of 100bp and above, but no more than 200bp.
Caution about concessions
The banks countered that Korea was a troubled borrower, renegotiating the debts of its banks under circumstances of duress. For the banks it was important not to concede too much to Korea. If pricing was clearly below market, their own boards of directors, external auditors and even their regulators might insist on provisioning against them. No bank wants to negotiate a loan and immediately be forced to write it down below par.
The banks reminded the Koreans this was supposed to be a voluntary deal. It had to be sold not just to the banks in the negotiating room, most with long-term commitments to Korea, but to over 200 other lenders around the world, some perhaps with little at stake in Korea other than getting their money back.
A compromise emerged in the middle of the afternoon on Wednesday January 28. Pricing would be 225bp over Libor for one-year loans, 250bp over on the two-year and 275bp over on the three-year. Three hours passed while the Korean team reported back to Seoul and the agreement was closed just before 8pm. Having blinked on pricing – they had hoped for under 200bp on the one year loans – the Koreans insisted, as a final point, on being able to pre-pay the debt, assuming they mustered the financial wherewithal to do so. “Three to six months from now, these spreads will look quite good,” predicts Rhodes. There is a real chance the Koreans may refinance the second- and third-year portions.
“This was a set of margins that anticipated credit and credit-rating improvement,” says Pflug. Indeed Fitch IBCA upgraded Korea from B minus to BB+ on February 2, citing the swift and successful conclusion of the bank negotiations, and Standard & Poor’s upgraded from B+ to BB+ on February 18, putting Korea back to within one notch of investment grade.
To the veterans of debt negotiations with Latin American countries, which dragged on for months and years, the negotiations with Korea were remarkable for their speed and intensity. “The banks weren’t whining. There was very much a ‘can do’ attitude,” says one official. “The sense of urgency on the private-sector side was quite impressive. This was not a restructuring committee. It was a group of institutions trying to put a deal together.”
The mere signing of the deal was a big boost to Korea. In early February, Rhodes saw the chairman of one of the largest Korean banks. “He told me that this deal will open the door to additional voluntary trade finance,” says Rhodes, “because international lenders will feel that much of their existing outstanding has been strengthened.” But for all this optimism, some bankers warn against declaring victory too soon.
When Rhodes and Duck-Koo Chung announced the agreement of the Korean government and 13 banks to extend the maturities of $24 billion of short-term credits to Korean banks, the story did not end. Those 13 banks together own 30% to 40% of the $24 billion in debt. To make the deal work, the lead banks and the Koreans must now persuade 200 other banks worldwide to support the programme and make sure it is completed by March 31, when the original roll-over agreement expires.
Contingency plans have to be made in case the exchange does not succeed, or only partly. If $20 billion or more of the $24 billion debt is submitted, the deal goes ahead automatically. If it’s $18 billion to $20 billion, Korea can consider its options but can still decide unilaterally to go ahead and exchange submitted debt. If it’s less than $18 billion, a mechanism allows those banks that have submitted loans to vote on whether or not to proceed.
And so to market
Assuming the exchange does succeed on schedule, Korea will move quickly to the next step: going to the international bond markets for the first time with pure sovereign bonds. It will issue $9 billion this year, having sold $1 billion domestically of the $10 billion for which it has approval. Goldman and Salomon will be lead-managers.
The Koreans intend to waste no time, hoping that by the third week of March or by very early in April, good news over the loan-maturity extension will further tighten spreads on outstanding quasi-sovereign dollar bonds. Their strategy will be to lengthen the maturity of their liability portfolio, perhaps by launching at maturities of three, five and seven years.
Korea’s first sovereign bonds
The success of bond offerings in turn will depend on continuing good reports on Korea from the IMF, a peaceful political transition and absence of severe social unrest as the economy contracts and restructures, and on what investors perceive to be the sovereign’s contingent liabilities. What other private-sector debts might Korea extend a sovereign guarantee to as past excesses are paid for in more and more bankruptcies? “It is important to note they are not guaranteeing any chaebol debt,” says one banker. “They are just addressing the core of the banking system. The IMF would get very agitated if public money began to be used to prop up the chaebols,” says one banker.
The bankers who sat through the negotiations are unanimous that Rhodes emerged as the hero, assuming leadership of the bank effort almost by a natural process. “Getting an agreement in that short space of time was a miracle. And Bill Rhodes is the chief reason it happened,” says Pflug at Chase. For Rhodes, a veteran of the protracted and painful resolution of the Latin American debt crisis, the speedy prevention of a Korean debt moratorium was perhaps his finest hour. Korea and its banks were staring into the abyss. Rhodes says: “When John Reed asked me to become involved in Korea, the country was well on its way to default, haemorrhaging $1-1.7 billion a day from its international reserves. In the first few days we also were worried that the IMF wouldn’t continue its disbursements, that there would be no second line of defence money, and that all of this would eventually lead to default and set a terribly negative precedent for other countries in Asia.”
