“We gave our lead managers a very hard time.” Kwon Tae-Shin, deputy director general of the ministry of finance and economy’s international finance bureau, smiles as he describes the negotiations behind Korea’s debt debut. Issuer and lead managers, Goldman Sachs and Salomon Smith Barney, clashed hard on everything from price to fee structures. All night meetings were common. One went on till 3.30am in the bowels of New York’s Four Seasons Hotel just hours before the deal was to be launched.
This was no ordinary capital markets deal. The Republic’s April $4 billion debut was make or break for Korea itself. “We had a responsibility to save our country,” says Kwon. “If we failed then no Korean banks or companies would be able to go to the financial markets again. We might go into a second crisis.” At the same time, MOFE faced enormous political pressure to ensure the deal was tightly priced and performed well after launch. Head of the Goldman team Carlos Cordeiro reflects: “Our challenge was: how tight could you drive the deal without it blowing up in your face?”
Running on empty
The story starts back in December. At this point Korea was running on empty with less than $6 billion in reserves and Seoul knew the country was in crisis. On December 8, then deputy prime minister, Lim Chang Yeul, drafted Byeon Yangho into the MOFE’s international finance bureau as a director. Byeon had joined the MOFE in 1978 having come top of the prestigious MOFE entrance exam. A brilliant mind and a US trained economist, he has worked mainly on monetary policy as well as putting in a short stint at the IMF in the early 1990s. Lucid especially in English – he is soft spoken and makes an unlikely hero.
When he transferred to the fifth floor of the MOFE’s nondescript yellow-brick headquarters in Gwachun the rating agencies had downgraded the country to junk. An international bond issue by state-backed Korea Development Bank had been pulled and the spread on outstanding 10-year KDB paper had widened to around 1,000bp. Worse still, the presidential election left Korea rudderless until February 25 when the new president would take office.
Deputy prime minister Lim had already decided to switch camps to new president Kim Dae Jung’s coalition. But in the meantime he formed a three man Emergency Committee for Economic Stability of which he was a member. This committee was to act as a bridge between the outgoing government and the incoming one. Its other members were Kim Dae Jung’s special economic adviser You Jong Keun, and Kim Yog Hwan, deputy boss of the United Liberal Democrats (ULD), which formed the other key part of the new president’s coalition.
The head of the ULD, and Kim Yog Hwan’s boss, is Posco founder, Park Tae Joon – a man widely regarded as Korea’s economic tsar. His son-in-law is Michael Byungju Kim, chief operating officer of Salomon Smith Barney’s Asian investment banking business. It was no surprise that Kim was one of those invited to a special crisis meeting on December 18 at the Shilla Hotel. The election results were being flashed up as the meeting went ahead.
“It lasted from 6pm till midnight,” recalls Kim. “Ourselves and Goldman were given a mandate that night to advise the government on ‘the development and implementation of a financing strategy’.” That night, says Kim, both firms did their first of many “all nighters”. There were no discussions about advisory fees, he adds. Both firms – at that stage – were working for free.
Goldman’s Asian fixed income boss, Cordeiro and well-connected Goldman Sachs International vice-chairman Robert Hormats had been courting Lim and his colleagues in the preceding weeks. Lim’s confidence in Goldman was later reflected when he chose Goldman partner Gerald Corrigan as a personal adviser. Lim wanted Corrigan because of his experience of the Latin debt crises of the 1980s when he was chairman of the New York Federal Reserve. He also reckoned Corrigan’s relationship with US treasury secretary Robert Rubin – a former Goldman partner – would be useful given the US’s predominant role in any international bailout.
The most urgent problem was the roll-over of $24 billion of foreign commercial bank debt owed by the Korean banking sector. The advice of both investment banks was to reschedule this first and then issue new debt in the form of international bonds to replenish foreign reserves and instil confidence.
Salomon and Goldman flew in their credit rating advisory teams and invited S&P, Moody’s and Fitch-IBCA to Seoul in the week beginning January 12. The advisors helped the Koreans sort through their data to get as clear a picture of the economy as possible. President-elect Kim agreed to see the agencies to answer their questions about political risk. In tandem, Goldman and Salomon produced a preliminary prospectus.
Playing hardball
There followed a period of frenetic activity (see Euromoney‘s cover story March 1998). The outcome on January 18 was a plan to exchange the bank debt into government-guaranteed debt of one-, two- and three-year maturities. These tranches would yield 225bp over Libor, 250bp and 275bp respectively. A few months earlier Korea’s institutions had been able to borrow at around 50bp over treasuries. These new levels hurt national pride – they wanted 200bp on the one-year tranche – but, in a precursor of what would follow, the Koreans refused to accept market price talk (investors had indicated they wanted up to 400bp on the longer maturities). The hardball tactics worked. About 96% of the 200 key banks agreed to the exchange, which took place on March 12. The immediate problem was solved. The next phase – a global bond – beckoned.
Kwon, Byeon and the rest of the team in the international finance bureau – led by director general Kim Woo Suk – then found themselves victims of their own success. With the debt exchange a success and reserves back to $24 billion, there was a backlash in Korea against launching the bond. Why issue an expensive bond today, said critics, when Korea will soon be investment grade again and a bond can be issued more cheaply?
But the argument was flawed. To get upgraded, Korea had to raise new money. And in their negotiations with the commercial lenders the Koreans had promised to raise around $10 billion of new money in the international capital markets. The term sheet for the debt exchange even contained this promise – although it wasn’t specific about when the capital raising would be.
Having won this battle, the team still had to decide the size and maturity of the debut. As late as mid-March nothing was firm. The government had registered a $5 billion shelf in the US, but from the outset questioned the advice of the lead-managers to make the debut big and long-dated. If money was expensive, they argued, better to borrow less and over a shorter maturity. Byeon and his boss Kwon agreed with the leads. It was not a particularly comfortable position, and attracted some domestic criticism.
Goldman and Salomon were also under attack from outside. Both firms had been selected as so-called lead managers in late February. However rivals still tried to wrest the deal away from them. The charge was levelled that, as Korea’s advisers, Goldman and Salomon could not be its leads. Stories were planted in local newspapers. It was whispered to senior political figures that the issue would be a failure.
Knowing they would be scapegoats if the deal failed or looked too expensive, the MOFE officials were desperate to appear tough in the eyes of their domestic audience. First they attacked on fees. Just hours before they were due to leave for Hong Kong for the first leg of the roadshow, the Koreans called a meeting at MOFE headquarters.
The show-down lasted from about four in the afternoon until around half past seven, and was to be the first of many. The leads had proposed a fee structure of 0.87% on the first $2 million with a sliding scale for the rest. There is no convention for non-investment grade credits, so the fee is always negotiable. When Mexico returned to the markets in 1995 post-tequila it paid 1%. The Koreans wanted a flat 0.75%.
A rival bank had proposed fees of 0.50% and Kwon, with Byeon at his side, brandished the pitchbook and showed it to the increasingly exasperated Goldman and Salomon bankers across the table. The meeting had already worn on for around three hours. One of the bankers seized the pitchbook and slammed it on the table. Unfortunately it span across the glass surface like a frisbee and hit Kwon on the chest. Kwon flew into a rage. Never in his long career had anyone thrown a book at him, he said. Then with finality he said he was not prepared to go on the roadshow if the fees weren’t cut to his liking.
The lead management teams convened a meeting outside. New York was closed, so they had to take the decision themselves. They gave in. They also agreed to another Korean demand. Instead of allocating themselves 90% of the bonds, to ensure full control of the deal, they took 80%, leaving 20% to the co-managers.
The pitchbook thrower says Kwon hugged him a few days later, to show there were no hard feelings. When Euromoney interviewed Kwon that banker’s business card was one of only two permanently displayed beneath the bureaucrat’s glass table-top.
On the road again
There was little time for recrimination anyway. The roadshow was due to start on Thursday March 26 and was to be one of the most gruelling and rigorous ever attempted. Team A would take in Europe (Milan, Frankfurt, London) then transfer to the US (Los Angeles, Chicago, Boston, Hertford). Team B would follow an Asian route (Hong Kong, Singapore, Tokyo) and then also hit the US (San Francisco, Minneapolis, Milwaukee). Both would then converge on New York on April 2, one week into the roadshow, with Team C – which fielded minister of finance Lee Kyu Sung. The roadshow took in 575 institutional investors, 46 of whom took part in hour-long one-to-one meetings.
Before the roadshow began, both lead managers had to coach the senior Korean officials. “We explained to them that the way they negotiated the re-extension of the debt [with the commercial banks] was a very different process to the one they were about to embark on,” says Stephen Roberts, Salomon’s head of Asian fixed income. In that instance, the Koreans had enormous leverage. After all, the banks already owned Korea. In this roadshow, investors had to be persuaded to buy Korea.
“Sometimes we felt like salespeople,” recalls Kwon, who led team B in his first ever roadshow. This he points out, was an unusual experience. “As government officials, we are used to meeting foreign investors in our office.” Kwon adapted to his new role with gusto. “Whenever big investors asked me difficult questions that I didn’t know the answer to, I would call them back later with the answer from my hotel.”
Team B was led by Byeon and Korea’s ambassador at large, former finance minister Chung In Young – who was partly selected for his excellent command of English. Byeon is credited with being the most brilliant of the Koreans in the questions and answers that followed the standard presentation. He recalls how the questions got more difficult as the roadshow progressed. “The Italian and German investors were so polite. In London, there were some investors who asked difficult questions. From LA onwards the investors were really well prepared.”
In LA he was particularly impressed by Pimco, who arrived in a group of five and were “armed with questions”. Pimco didn’t even want to go through the flip-presentation – “it just wanted to start asking questions straightaway,” says one of those present.
However, the toughest grilling came from a fund manager from John Hancock Mutual in Boston. Most of the one-on-ones lasted an hour at most, but this particular meeting – scheduled for the end of the day – went on for two and a half hours. Byeon was fascinated by the perceptiveness of the fund manager’s questions and told him at the end, “I think you know Korea better than most Korean economists.” It was an important account to win over – the fund has a reputation as a lock and hold investor rather than a flipper.
Byeon admits to getting tired and there was ample scope for fatigue. In New York, the lead managers built a “war room” in the Four Seasons hotel. In one day the Koreans did 11 one-on-ones and a conference call. Normally the issuer goes to the offices of the fund manager. The Korea deal was also unusual in the respect that big funds came to see the borrower in the war room. It was a question of supply and demand. There were over 200 informal requests for private meetings. Only about a quarter got them.
Keeping control
There was good news. Three days into the roadshow Moody’s confirmed Korea’s Ba1 rating and upgraded the outlook from negative to stable. Investors continued to flock to presentations. Over 200 turned up at the Shangri-La in Hong Kong on March 26. In London, the venue had to be switched at the last minute to an auditorium. A sit-down lunch was abandoned to provide more space and a buffet was offered afterwards instead.
It was in London that the 13 co-managers first started to complain about their treatment. One complained that he was prevented from entering the presentation by a burly bodyguard, and likened it to trying to get into a rock concert without a ticket. Others moaned that they would take a team of five only to have the leads send three of them home. They also complained they were cut out of the information flow.
Goldman and Salomon, more interested in presenting to investors than co-managers, do not deny this. “The co-managers were kept in the dark by design,” says Cordeiro. “You couldn’t have 10 captains running a deal of this size. We wanted to control the information very tightly.”
There were logistical hiccups. Kwon’s team A planned to fly from Milwaukee to New York on April 1, but a tornado stranded them at the airport from 7.30pm till they found a hotel around midnight. So they missed four one-on-ones the next morning. Luckily one of their colleagues, Moon Hong Sung, a deputy director in the international finance division, had gone on ahead and did these on his own. “My concern,” he recalls, “was having to do the luncheon presentation on my own too.” This looked a distinct possibility as Byeon’s team – which had hooked up with the minister of finance in Boston – was also delayed.
Team A was still stuck in Milwaukee. Their 8am flight was delayed so that Kwon only arrived at JFK airport at midday. “By mobile phone we were told the minister was delayed too,” says Kwon. The lunch presentation was moved back to 12.40, when all the participants arrived and converged on the same place for the first time since leaving Seoul.
Even so Kwon’s team only just made it. The limousine driver called the police on his mobile phone and told them he had an important foreign government delegation and it was an emergency. The police gave him permission to break the speed limit and avoid traffic jams by using the hard shoulder.
Over the course of the roadshow there were a few more serious problems. First and foremost was Korean state-owned power utility Kepco which issued $250 million of three-year bonds on March 27 at a spread of 430bp over treasuries. The MOFE had been consulted about this JP Morgan-led deal and had been told it would be a very private placement with just two investors. Inevitably the deal was touted around the investment community and inevitably Goldman and Salomon found out about it.
When they saw the price, the two lead managers were livid. They felt sure investors would use the state-guaranteed issuer as a benchmark for the sovereign deal. The strategy of avoiding all discussion of price during the roadshow and focusing on the economy was in tatters.
Byeon was in London’s Shilla restaurant eating a Korean dinner when he heard the news. His face, according to observers, went ashen. He had thought the Kepco issue would be done after the republic’s. Salomon’s Kim was sitting next to him and had his mobile phone grabbed from his palm. Byeon went outside. It was late in London and 5am in Seoul when the groggy general manager of Kepco’s international finance division got the call. If the Kepco deal had an adverse impact on the republic’s pricing, he was told, he could expect to feel the full force of the MOFE’s ire. Nor did JP Morgan’s Korean representative escape the wake-up call .
Byeon recalls the ensuing panic: “The lead managers were very stressed and kept mentioning Kepco, and bad pricing. I was so angry. I said do not mention Kepco to me again. What is our strategy to make people forget about Kepco?” It turned out that 10 days proved long enough to make them forget.
Things got worse. On March 31, the Republic of Brazil launched a $1.25 billion 10-year deal which widened after launch from 375bp to nearly 415bp. Then just days before Korea’s launch, the Republic of the Philippines sneaked in with a $500 million 10-year bond led by Morgan Stanley and JP Morgan. The deal’s timing caused a good deal of consternation in the Korean camp. Some investors told Byeon what he didn’t want to hear – they wouldn’t touch Korea below 400bp. “I told them that if the price was 400bp we wouldn’t issue,” recalls Byeon.
Then on Friday April 3, as the roadshow came to a close in New York and the pricing discussions began, Moody’s announced it was revising Japan’s credit outlook from stable to negative. The impact on spreads was cataclysmic – especially in Asia.
Just 24 hours before – cautiously optimistic after a successful roadshow – Salomon and Goldman had proposed a deal at 375bp over. As far as the Koreans were concerned this level was totally unacceptable, especially since the Philippines had got 10-year money at 338bp over. After the Moody’s announcement certain members of the lead management team began suggesting to MOFE officials the price should be closer to 400bp. That triggered a period of “creative tension” – in other words a complete stand-off. The Koreans insisted on 345bp, while the leads refused to budge from 375bp. It was deadlock throughout the afternoon.
The MOFE officials were novices at this kind of game and had brought along domestic advisers to help them out. These were Kim Jin Kyung from the Export-Import Bank of Korea (Kexim), Cho Jae Ku from Posco and Kim Duck Soo from Korea Development Bank (KDB). The latter had been KDB’s long serving – and highly aggressive – borrowing head until the middle of last year when he was transferred into the lending department. His long experience was considered so valuable that the MOFE passed over his successor to enlist his advice.
These advisers suggested a new tactic. Why not re-incentivize the leads? There was a suspicion that they felt a bit bruised by Kwon’s victory on the fees and that if the payout was increased, the leads might try harder. Accordingly Byeon told both firms that he would ask the minister of finance to increase the fees by 5bp if they managed to get the 10-year tranche below 350bp. This offer was left open for the remainder of the negotiations.
Nerves were fraying. One co-manager told the wire services that the deal had been cancelled. Salomon reacted swiftly. A senior member of its syndicate desk called his counterpart at the co-manager in question: “I want to know who it is at your place whose spreading these rumours. Whoever it is, shoot him, put him in a bodybag and send him round here, or else you’re out of the deal.”
Late on Friday, the lead managers said they were going to approach 10 key investors with a price range of 375bp on the 10-year and 365bp on the five-year. The Koreans were livid. After a heated debate they grudgingly agreed but insisted the price talk shouldn’t go beyond the selected 10. Just before dinner another argument erupted. The Koreans said they weren’t happy with the pricing and wanted a delay. They would wait to see how the market reacted on Monday.
That night the Koreans dined at the Korea Palace restaurant, Byeon not saying a word, and hardly touching his food. The next morning the minister of finance and Kwon, who 20 years earlier had written a thesis on the determinants of Euromarket spreads, left for Seoul, leaving Byeon and his superior, the director general Kim Woo Suk, to manage the negotiations. Byeon remembers it being a cold and rainy weekend. On the Saturday he wondered around a shopping mall. On the Sunday there was nothing to do, so – bored and nervous – he went back to the shopping mall again.
Price war
On Monday morning it became clear that the impact of Moody’s announcement had not carried over to Monday. Asian debt was trading normally again. This was apparent by the time New York opened and the Asian day was over.
On Salomon’s trading floor however there had been another seismic announcement. At 7am Salomon boss, Deryck Maughan, announced the merger of Travellers Group with Citibank, something to break the concentration of even the most dedicated dealmaker at Salomon.
With sentiment rapidly improving, the leads suggested the price could be tighter and planted their flag at 365bp for 10-year money. The Koreans maintained their position at 345bp.
That evening, in a conference room in the basement of the Four Seasons hotel, the two sides sat down to thrash out the level of price guidance. This would tell investors where the bond would be priced – and was good for 5bp either side of the prescribed level.
From Salomon there were head of international syndicate John Purcell, Michael Kim, Stephen Roberts and yankee head Phil Bennett. From Goldman, all the talking was done by syndicate vice-president Mark Bamford and Carlos Cordeiro. The Koreans spoke through Kim Woo Suk and Byeon. “Byeon ran this deal,” comments one banker who worked on the transaction. “He is the protagonist and hero.”
The Korean tactic – a familiar one – was to wear down their opponents through sheer force of will. The Koreans noted that the Philippines deal had been launched at 338bp and since both had the same credit rating, Ba1/BB+, their objective of 345bp was not unreasonable.
Salomon and Goldman presented a united front. They pointed out that by December, or perhaps a little earlier, the Koreans would be able to price inside the Philippines. But today this was no longer possible. The Philippines was perceived to be less chaotic than Korea, so the country would have to pay up. Market talk also suggested the Philippines had come very, very tight. And at $500 million it was a small deal compared with Korea’s which promised to be one of the largest of the year. The Koreans should ignore the Philippines and consider Brazil the week before. Then the price talk was too tight and the deal widened 30bp.
These arguments were laid out, repeatedly, through a long night that was more about patience than debating skills. Three times the issuer and its bankers broke-up the meeting to get some air. At one stage, Kim said “If we cannot justify this to the Korean people we cannot price the deal.” The syndicate managers didn’t even flinch. “This is the right price. Full stop,” they replied.
One of the Koreans later joked that Goldman’s Cordeiro was so obstinate that “he must have some Korean blood in him”. Cordeiro – for the record – is half-Indian, and half-Colombian. And what neither he nor the other leads knew was the Koreans were negotiating from a position of weakness. Their superiors in Seoul had forbidden them to pull the deal at any cost.
By 3.30am the meeting – which had started nine hours before – finally broke up. It was decided that price guidance would be set at 362.5bp.
Over Tuesday the leads built the book. Sentiment continued to improve throughout the day and by the evening the leads could show $12 billion of demand at 362.5bp, with less eagerness at 357.5bp.
There was no book at 355bp or 353bp, so the emboldened Koreans asked what the leads estimated the demand would be at these levels. At 355bp a comfortable figure was given, but at 353bp both leads suggested it was too risky. Demand simply dropped away. Some of the senior figures in Seoul where so excited by the $12 billion figure that they assumed they could slash the price as a result. The 5bp bonus fee was resurrected and promised to the leads if they launched the 10 year at below 350bp.
Kim and Byeon consulted their domestic advisers. But Kim Duck Soo and the others agreed with the leads that the risk of pricing at 353bp was too great. However, 355bp was about right, they thought.
Moving the price to 355bp posed a considerable problem for the leads. Their salespeople had approached investors with a floor of 357.5bp. At this price all orders were good. Suddenly, they didn’t have a book. The Koreans offered to increase the deal from $3 billion to $4 billion in return for tightening the price to 355bp.
The next morning, both Goldman’s and Salomon’s salesforces had to call every account and ask if their order was still good at 355bp. At 9am it was also announced the deal would be increased. The deal was due to be formally priced off the US treasury curve at 11.30, and so the two salesforces spent a frantic two and a half hours calling nearly 500 accounts. Rough allocations had already been decided based on the book built the previous day. If this changed radically then so too would the allocations. In the event, 422 accounts bought the deal. Many of these accounts were the same ones that had told Byeon they wouldn’t touch Korea at anything less than 400bp – an interesting insight into investor psychology for the debut borrower.
The $1 billion five-year issue was launched at 345bp over. Because of peculiarities in the swap curve both maturities were swapped at an identical 304bp over Libor. The bonds were 12 times oversubscribed and changed investor sentiment towards all emerging market debt. Easily Asia’s biggest ever debt deal to date, it led a mass rally in spreads.
The 10-year traded in to 315bp by mid-April leading to accusations of mispricing. These are unfair. “Could anybody feasibly have priced the bond at 315bp?” asks Roberts rhetorically. “No. It just demonstrated the level of momentum in the market.”
As if to emphasize how finely balanced between success and failure the deal was, the 10-year had widened to 442bp by May 18, a victim of its own liquidity as Indonesia seemingly slid towards civil war and both KDB and Kexim were downgraded. The loss of their sovereign ratings went unprotested by the government lending weight to Moody’s assessment that the government’s commitment and responsibility to these institutions does not constitute a direct and unconditional guarantee of repayment of their liabilities.
The truth is the deal was priced on a knife-edge and could have gone wrong, with disastrous consequences for Korea and the region. “This was a deal that was either going to be very successful or a failure,” says Cordeiro. “The success of this transaction tightened spreads across all emerging markets overnight.” Within a week Brazil ’08s and Philippines ’08s tightened 20bp. For once events in the international bond markets had global significance.
