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| Smith: saw good Asian companies hit along with the bad |
When the financial crisis broke across Asia in the second half of 1997, the best companies were hit just as hard as the good. It was a shock of such sudden appearance and virulent intensity that no-one could have been prepared for it. “Even the top Hong Kong land companies with very conservative gearing levels of 20% or less and family owners measuring their net worth in billion of dollars – who must have thought that nothing much could harm them and that a crisis might even help the strong companies to stand out – suddenly found that banks simply stopped lending to them. The head offices of many Japanese, European and American banks completely reined in their Asian operations,” recalls Alan Smith, vice-chairman of CSFB in Asia. And with the domestic Asian banks drowning in bad debts, the result was a temporary seizure in credit that ushered in two years of panic and confusion. “If you see your net worth fall from $5 billion to $1 billion in a few months, it’s easy to imagine your last $1 billion disappearing too,” says Smith.
By the end of 1999, most Asian economies, Indonesia aside, have shown strong recoveries in economic growth, trade balances and foreign-currency reserves. Korea is likely to post GDP growth of more than 8% for 1999, Thailand just under 4%, the Philippines 3%, Malaysia 5%. Interest rates have returned to single digits in most countries following the surging inflation that accompanied currency devaluation in 1997. Current accounts have benefited and foreign exchange reserves been rebuilt. Stock markets have boomed. Hong Kong is up 30% this year, Korea up 120%, Malaysia nearly 70%, Singapore up 62%, Thailand up nearly 20%.
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| Cordeiro: private capital flows are resuming |
And in the credit markets, too, signs of recovery are becoming ever more apparent. Malaysia, which borrowed at 330 basis points over treasuries earlier this year, in a deal that seemed daring at the time, has seen spreads on its international bonds tighten towards 225bp; Korean spreads have come in from 400bp earlier this year to 225bp over the summer and to around 200bp in mid-November. In early 1997, KDB (Korea Development Bank) bonds had traded at as tight as 75bp over treasuries – at the worst point in the crisis at the end of that year, they were being quoted at 1,000bp over. “In the last few months, we have seen a resumption of private capital flows into the Asian bond markets for the first time in two years,” says Carlos Cordeiro, managing director at Goldman Sachs. However, he points out: “Flows are still less than they were pre-crisis largely because both international commercial banks and fund managers have reduced their exposure to Asia specifically and emerging markets more generally. Having said that, we are optimistic that global demand for Asian fixed income securities will continue to support an active new issue calendar in the new year.”
When credit rating agency Standard & Poor’s upgraded Malaysia and Korea in mid-November, it confirmed the resolution of those firms that had promoted their bonds through the tough times. “If KDB or Kexim [Export-Import Bank of Korea] did a deal today, depending on the maturity, they could raise debt with a coupon between 7.5 to 8%,” says Glenn Kim, head of debt capital markets at Lehman Brothers Asia. “We have always traded Korea off our high grade bond desk. From the start of this year, as the country began to be up-graded, we saw large inflows into Korea from mainstream investment-grade buyers like insurance companies, taking core positions in Korean debt for the coupon and spread performance, while cross-over buyers, hedge funds and global emerging market bond buyers increasingly looked to exit out of Korean sovereign debt. With the sovereign now trading in the mid to high 100s, we are also observing that investors, many of whom have benefited from tremendous spread compression on the Korean sovereign, are looking to diversify their Korean exposure and are selectively looking at strong names in the corporate sector. These names include Korea Telecom, Kepco[Korea Electric Power Co] and Posco [Pohang Iron & Steel Co] and possibly some attractive growth stories.”
At the worst point in the crisis, credits from China and Hong Kong were being quoted in the ragged remains of the thinly traded Asian bond market at spreads as wide as 800bp. At the height of enthusiasm for all things Asian in 1996 and early 1997, spreads had narrowed to 60bp over. This year has shown a marked recovery toward those levels. At the start of this year, Hong Kong’s Mass Transit Railway Corp sold a $750 million 10-year bond priced at 287.5bp over treasuries. Within a week it tightened to 244bp over. By late August it was at 190bp. And by mid-November, spreads on stronger Hong Kong and China credits were at around 150bp over treasuries.
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| Raymond Kwok: still gets bank loans but is diversifying funding |
Over a glass of iced water in the lobby of Island Shangri-La Hotel, Raymond Lai, finance director of the Airport Authority of Hong Kong (AAHK), reflects on the lunch he has just taken with a group of investment bankers who have been urging him to refinance a portion of his syndicated bank credits in the bond markets. They have been suggesting pricing of 150bp over treasuries, but Lai is inclined to wait. “The problem is that the greatest liquidity is in the short maturities of three to five years. Anywhere beyond that there is a premium to pay that may set a dangerous precedent. The Asian premium may have diminished but it is still there.” Privately some bankers agree, questioning why a borrower like the AAHK should have to pay any premium over that of a composite single-A-rated US corporate issuer which would expect to pay less than 100bp over treasuries.
Lai reasons that against a backdrop of economic improvement in Hong Kong and broadly in Asia, solid growth in passenger and cargo volumes through the airport and a shrinking premium on Asian credits, it may pay him to wait. “We want to lengthen the maturity of our existing stock of debt which, at an average of two years is far too short. We would like to borrow very long term so as to match the useful life of our assets, but there would be a price for doing that and so we will probably start at 10 years. Our $6.5 billion revolving credit gives us some flexibility and an issuing window of 18 to 24 months. In an improving market, time is on our side.” Bankers have been badgering Lai to refinance with a yankee or MTN issue, but he may keep them waiting until well into 2001.
The AAHK is owned by the Hong Kong government and may eventually, if the government’s sale of a stake in the Mass Transit Corporation is successful, be a candidate for stock market flotation. Meanwhile it operates as a public corporation with very low leverage. Its total debt of HK$6.5 billion (US$820 million) stands against the HK$50 billion cost of constructing the new airport. It has only modest additional capital expenditure in prospect. The position of the AAHK and its bankers sums up the disparity in Asia between top-quality names that bond market investors would love to buy, but which have no great need nor particular desire to issue, and all the rest, for which liquidity remains scarce.
Mark Bucknall, global head of debt capital markets at HSBC, says: “In the international markets this year there have been issues either for sovereigns and quasi-sovereigns or below investment grade corporates paying 900bp over. There has been almost no middle ground.” Demand has been high for a few select corporate deals. At the end of October, China Telecom did a simultaneous $2 billion equity offering through Bear Stearns, Goldman Sachs and China International Capital Corp, and a $600 million five-year bond deal led by Bank of China International, Chase and Merrill Lynch into highly discriminating markets. Just two weeks earlier the $2.5 billion IPO of China National Offshore Oil Corp had been pulled.
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| Bucknall: expects to see more middle-ground issuers next year |
But both China Telecom deals succeeded. Samuel Poon, head of debt capital markets at Merrill Lynch in Asia, explains: “China Telecom is a $50 billion market capitalization company with very little debt. And the telecom story is very well understood by investors around the world. That far outweighed the fact that the company has no dollar flows. We started the roadshow in Asia and there was talk in the press of pricing in the 220bp to 240bp range. We did not respond to this but instead focused on generating indications of interest from investors. We got a strong sense that US investors, who have not been given too many opportunities to buy new issues since July as issuers such as KCRC [Kowloon-Canton Railway Corp] and IBK [Industrial Bank of Korea] opted for the Eurobond route, would be prepared to bid more aggressively this time. Our sense was proven right and strong momentum developed in the US, where investors were willing to take under 200bp.” The deal attracted a $2 billion order book, was priced at 190bp over treasuries and soon traded in to 180bp. “But does that mean we could do the same for any other Chinese company – not necessarily,” says Poon.
Some of the more challenging deals this year have been those that moved the spreads of quasi-sovereign issuers and public policy banks back closer to sovereign spreads. Before the Asian crisis if a sovereign bond traded at 150bp over treasuries, the state development bank would trade at 160bp. At the worst point in the crisis that gap between sovereign issues and second-liners widened to 200bp to 400bp. This was a judgement as much on liquidity of specific deals as on credit fundamentals. “It was illiquidity that most frightened investors during the crisis and it’s taken a long time for liquidity to come back. There has been a preference for big liquid issues. In those front-line deals you can trade $10 million on a 5bp to 6bp spread, whereas pre-crisis it was $15 million on a 3bp to 4bp spread and during the crisis you might be quoted a 25bp spread on a very small order.” As liquidity improves, so spreads on quasi-sovereigns are tightening back. IBK had been trading at 60bp wide of KDB, until its recent bond repositioned it at 25bp wide of KDB.
Amid all this activity, breakthrough corporate deals have been rare. Cordeiro at Goldman highlights the $200 million five-year deal for Ayala. “Ayala is synonymous with the Philippines. It’s dominant in financial services, real estate and telecoms. Still, 10 to twelve months ago, it would have been a stretch to bring at such competitive levels an unrated Philippines corporate, even the likes of Ayala.” Goldman compensated for this lack of a rating by striving to match international disclosure standards through the prospectus. There are still no hard-and-fast rules for prospectuses on Asian issues and standards vary widely. Some of the more successful deals this year, including the $870 million issue off convertible preferred shares for Siam Commercial Bank, have raised the bar for full disclosure in prospectuses. The Ayala deal was listed in Luxembourg and structured as a euro 144a deal, but it was Asian investors that seemed to take most comfort from the high level of disclosure. Fully 80% of that deal was placed within Asia. Asian investors’ buying of Asian credits has been one of the more encouraging developments of 1999.
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| Seah: OUB stands out for wanting to lend |
But encouraging developments are limited. The local banks in Korea and Thailand face huge overhangs of domestic bad debts. The Hong Kong banks are stronger but remain cautious lenders. They are highly liquid but are locked in a battle among themselves for what they all regard as the single most desirable asset available: high-quality residential mortgages at 70% loan-to-value ratios. Raymond Kwok Ping Luen, vice-chairman and managing director of Sun Hung Kai Properties, which the Kwok family controls, points out: “The banks like to lend to good names like us. But in general they are very reluctant to lend. The write-offs of 1998 and 1999 have been very serious and now, at the early phase of recovery, they are still sorting out bad debt problems and selling repossessed properties.”
Sun Hung Kai Properties is one of the pre-eminent corporate names in the region. Although the group has low gearing, just 12% debt to equity, it claims to have adequate committed unsecured bank lines to pursue a policy of buying at the bottom. Raymond Kwok says: “It’s good for us when the signal are mixed on the market and the economy, it’s an opportunity to look through those signals, take proprietary positions and be a winner.” It’s notable that Sun Hung Kai is also diversifying its sources of funds in the capital markets. It has raised the equivalent of $400 million off a euro medium-term note programme established at the start of this year and which it recently increased to $1.5 billion from an initial $500 million. It seems that even such strong names may worry about the reliability of banks in a crisis.
The Singapore banks have also emerged in reasonable shape from the crisis. By traditional measures they look overcapitalized. But their propensity to do any lending is mixed at best and building regional franchises through acquisition seems to be the priority.
The bank attracting most attention in Asia right now is DBS Bank. It has a new senior management team led by ex-JP Morgan banker John Olds, who is the CEO. Since March of last year it has gone on an acquisition spree, buying 50% of Thai Danu Bank, 60% of Bank of East Asia in the Philippines, and 100% of Kwong On bank in Hong Kong.
Yet as at June this year, DBS still had 85% of its assets in Singapore and though its acquisitions may have boosted total assets, it shows no great appetite to expand credit in the region. After excluding those new acquisitions, non-bank loans are actually shrinking.
“A real issue for Asia is to fix its banking systems so that economies can grow again at something close to their pre-crisis rates,” says DBS’s Olds. “This requires strong local leadership, politically and economically. Institutions like the World Bank, the ADB and the IMF have less experience at the micro level and in banking system work-outs. There are some signs of this happening. In Korea there is a growing will to clean up as exemplified by the Daewoo situation, for example. In Thailand, new bankruptcy laws may have been passed over the strenuous objections of some: but, after enactment and two years of training lawyers to process creates, not enough is moving through the courts to create tangible results. Absent resolution and the establishment of useful precedents, the laws have no teeth. Borrowers have less incentive to settle.
“If Asia does not fix its banking systems, it will have continuing problems because while equity markets have recovered, the region has not had time enough to create broad and deep capital markets large enough to take the pressure off the banking system.”
It is clear that the crisis has marked an end to the period when excessive amounts of low-cost funding was available to the politically well-connected privileged classes, and that the region may soon produce its share of strong competitors in global industries. For the short term, though, Olds is intent on internal rebuilding and reorganization. “This is not an environment in which to build assets. Loans are likely to remain flat for the better part of next year as well. Our focus is on building practices and procedures and building a web-based distribution strategy in financial services. Our intention is thus to start generating improved returns by 2001-2002 when some of the investments in people, processes and markets have begun to take hold. By then we should also have largely cleaned up the balance sheet, put better-trained people in the field, built a more diverse capital structure and reinforced our position as one of Asia’s main regional banks.”
The lead group to which DBS aspires includes HSBC, Citibank and Standard Chartered. Even these strong banks are scarcely falling over themselves to lend in Asia. That may in part be a function of weak loan demand because of remaining excess capacity in many industries. “Asia has over-invested in the past and there are still plenty of empty plants around. Funding is still more refinancing and trying to repair the capital base, rather than funding for growth,” says Merrill Lynch’s Poon. Poon had hoped that 1999 would be the year of wide-ranging equity recapitalization for Asian companies, but this has been spotty at best. “Indonesia is not coming through yet, and many Korean banks are still busy sorting out their problem loans; a few have managed to raise equity but some other bank equity deals have been pulled. My sense is that next year we will see more equity deals and only after that more debt issues.” Poon’s favourite candidates will be issuers from sectors with predominantly US dollar flows.
Banks’ excess liquidity may in part be being built up in nervous anticipation of a down-leg to follow the V-shaped correction in Asian financial markets. And it’s not just the Asian banks which remain cautious.
Avinder Bindra, deputy chief executive of Citicorp International and head of global loan products for Asia, Japan and Australia, says: “It will take another year or so before there is much new capital investment coming in and until then banks will still mainly be working on restructuring or refinancing of companies’ existing debts.” Smith at CSFB adds that even among stronger regional corporates that may have viable projects in the pipeline, there is a tendency to restraint. “There is a sense that this is not the best time to finance them.”
Citibank’s loan group has made most of its money in Asia in 1998 and 1999 by buying assets in the secondary market and positioning for tightening credit spreads. Tellingly though, supply of performing assets has now dried up. New financings have been few and far between though Bindra was pleased with the reception for an eight-year $150 million deal for Siam City Cement, which attracted $200 million in commitments. The company’s restructuring – it brought in world-leading Switzerland-based cement company Holderbank as a shareholder and to provide management – provides him with a rule of thumb for companies in Asia that may be most worth lending to and investing in. These, Bindra says, are “professionally run companies, where the owner may have stepped back and concluded that it’s better to own 20% of a company that works than 80% of a company that’s broken”.
Asian financial leaders struggle to portray successful regional corporations in more precise terms. Peter Seah Lim Huat, president and CEO of Overseas Union Bank, points out that “it’s easier to spot good companies in a recession. They’re the guys who are still hanging around”. He adds that OUB is lending to manufacturing and trading companies that have survived at a time when so many big conglomerates in the region have been wiped out, because either they have a particularly good niche business or are particularly well run”. Seah claims that OUB is something of an exception in being an Asian bank that actually wants to lend. “While most Singapore banks have won a lot of kudos for shrinking their loan portfolios, we have grown ours and been criticized for it. But my view is that you can either say this is a good time to be spotting opportunities, or you can run away and hide.”
OUB remains a predominantly domestic bank, with only 13% of its assets offshore – mainly in Malaysia (7% of total assets) and Hong Kong (4%). Its main franchise is among middle-market local companies, and Seah has been keen to ensure that it is remembered for sticking by these customers in the tough times. “Their concern is credit availability, not credit price. If your remove half the credit of a middle market company with 100 people, you’re writing its epitaph.” Seah argues that this class of customers has by and large performed well compared with some larger regional companies, whose owners had been siphoning off funds for years to speculate in the stock and property markets, and had grown used to being entitled to cheap credit on the basis of family name or political connection. Many of these chose to walk away from debts they could have paid. By contrast, Seah’s ideal OUB customer is a company that is “very focused in its operations, has conservative financial management, whose owners plough money back into the business. You find that these kinds of companies tend to recover from crisis – unless the business sector they operate in really goes down the tubes – and that they are also very committed to paying their debts. If things get tight, they’ll work out some way with you to meet their commitments”.
Meanwhile there are signs that some of the region’s state-owned corporations, such as the MTRC and the AAHK, are at least grasping principles of weighing the cost of capital against return on investment in projects. This calculation escaped certain Asian conglomerates that had in the past fed on cheap debt and equity. The AAHK is thinking about wringing more value out of its business. It has plans to expand its cargo capacity and to build more sophisticated warehousing and logistics centres near the airport to suit the distribution requirements of e-commerce companies and express delivery companies such as DHL, Federal Express and UPS. It intends to finance and to manage a new marine cargo centre at the airport. It’s reasoning: 70% of the cargo flown out of Hong Kong is first shipped from mainland China, mainly from cities in the Pearl river delta. So congested is the Hong Kong/China border now that delays are eating into the tight order-to-delivery times of Chinese manufacturers. Just moving goods from plants to the airport can take a day and a half, at a time when factories are aiming for the modern standard of zero inventory and 10-day turnround from order to delivery. The airport hopes to cut this to a few hours by setting up a non-stop high-speed ferry service to the airport from key mainland sites. It might joint venture this with the ferry services that have spare capacity at night when no passengers want to travel. It’s the kind of profit-maximizing venture the airport could not focus on during the years of construction and establishment of basic operations.
Elsewhere across the region, there is a sense that the large blue-chip companies won’t stand still while the Asian banks and lesser companies work out their problems. Hutchison Whampoa, for example, chaired by Li Ka-Shing, is positioned as a telecoms and port-operating company with broad exposure to developed and emerging markets. It has plentiful operating earnings and a cash hoard following its disposal at a tasty price of its holding in UK mobile phone network Orange. It has just negotiated a joint venture with international cable company Global Crossing to pursue internet opportunities in Hong Kong, Hutchison may soon be regarded as a global company whose credit rating is straining at the single-A sovereign ceiling imposed by its incorporation in Hong Kong.
DBS is another cash-rich institution now on the acquisition trail during a period of general weakness and striving to determine from a position of strength a strong industry position for the next 10 years. The region’s stronger airlines – Singapore Airlines and Cathay Pacific, for example – are surveying weak local competitors and available routes. “These are strong companies which have embraced the concepts of transparency and optimizing capital structure and are now using their strengths to grow through acquisition,” says Goldman’s Cordeiro.
