What will go wrong next?
Asian banks: Now comes the real crisis
Asian research: Worth the paper it's printed on?
Hedge funds: You can run but you can't hide
Country Risk December 1997: It could be worse
Global Economic Projections: Overall Rankings
With friends like these...
"The last time I saw something like that," commented one wry old hand, swigging a gin and tonic, "was when Drexel Burnham Lambert issued advertisements three days running denying they were insolvent. Of course, on the third day they went under..."
Hong Kong's business and banking elite were stunned by Peregrine's rearguard press action on October 27. Rumours about the firm were very bad indeed. But no-one expected the full-page advertisement in major newspapers denying them.
The ad, issued by order of the board, had a last paragraph printed entirely in capital letters. It stated: "Rumours of losses by Peregrine running into hundreds of millions of us dollars and of Peregrine's financial demise are completely false."
The advertisement included near-up-to-the-minute figures for the firm's performance. It stated that its (unaudited) net profits in equity trading and derivatives were $16 million in the year to October 24 - a fall of $23 million from the first-half figure. In fixed income the profits were $19 million - a fall of $14 million. It added that its financial year would be brought forward by a month to November.
Then it stated: "All major banking relationships and credit lines remain in place." This is perhaps tempting fate. Not surprisingly, Peregrine's troubles did not end with the advertisement. And so it took the even more unusual step of publicly announcing that it had hired a private investigator to trace the source of the scurrilous rumours.
How had the once-proud Peregrine been reduced to such gauche initiatives? The firm - which founder and chairman Philip Tose had wanted to call Falcon (he settled on Peregrine because that bird was "fast and agile") - had once again topped the league table for international equity issues for Asian issuers between January and September, having raised nearly $1.5 billion in 19 issues. It had announced record results for the first half of this year.
But a string of bad news in its regional operations and, worse still, the onset of the regional crisis that began in Thailand in July and cut the Hong Kong stock market in two in October, made Peregrine look vulnerable.
The firm - which was founded in 1988 and produced 160% annual compound growth in turnover between 1991 and 1995 - was the child of the Asian economic miracle. So when Asia went sour it was clear Peregrine was the investment bank likely to suffer most. Unlike some of its rivals, it could not hide its Asian losses in European or us gains. It is a regional firm, not a global one.
Peregrine began life as a Hong Kong brokerage, and many of its 1,700-strong staff must have wished it had not strayed so far from its equity roots. The feeling inside the equity camp at the firm was that the rumours were killing its ability to do business and that they were generated solely by the problems of the fixed-income division.
Peregrine chairman Philip Tose had decided in 1994 that for the firm to become a full-service investment bank it would need to be able to launch bonds for its clients. So he hired 34-year-old Andre Lee from Lehman Brothers to build a business from scratch. By 1997 Lee had expanded his original team of 25 to around 250 and operated the biggest fixed-income desk in the Asia-Pacific region. In 1996 he raised $22 billion for Asian corporates, compared with $9 billion in 1995.
This all looked great until this July. Every investment banker in Asia grudgingly praised Lee's strategy of doing grass-roots business in local Asian currencies. Then those currencies went to the wall, the markets crashed and default risks escalated.
Suddenly the strategy of holding a large portfolio of local-currency bonds and commercial paper began to look a poor one. Bids in the market went from wide to non-existent. The phrase "toxic waste" began to be used with increasing frequency to describe the sort of paper that Peregrine had pioneered. Additionally, the Korean merchant banks that had been the mainstay buyers of its product suddenly had a few problems of their own. They wanted to sell. Hence the rumours. Could Peregrine, with its $900 million of capital, take the pain?
Tose was on the backfoot. So long a fierce defender of his independence, he didn't want to be bought out by the sort of firm that would interfere with his buccaneering style. After all, he had founded the firm to avoid that fate - to escape the shackles of Citicorp, which having acquired Vickers da Costa, un-buccaneered the operation he ran there.
So it came as a surprise on November 17 when Tose announced a new shareholder. It is the Switzerland-based Zurich Centre Investments, the private-equity arm of insurer Zurich Group, which had a 1996 premium income of $23.7 billion. It bought $200 million of Peregrine equity-linked bonds convertible in January 2001 with a 7.5% coupon. This effectively gives Zurich 24.1% of Peregrine, three of the nine board seats, and the right to block major decisions on budgets, business plans and "certain material capital transactions".
In the process, Zurich became the firm's biggest single shareholder, supplanting Peregrine International Holdings. That is the shareholding structure in which Peregrine founders Tose and Francis Leung hold their stock. Peregrine's other major shareholders, Hong Kong entrepreneurs Li Ka Shing and Gordon Wu, and Larry Yung's Citic Pacific, were also overtaken in size by the European group.
In the interview with Euromoney that follows, Tose speaks of the Swiss investment, how it changes the nature of the firm, and why it was necessary.
Euromoney: Does the recent Asian crisis underline the strategic danger of being a regional investment bank, not a global player? After all, you had nowhere to hide once Asia went sour.
I think if you put it in those terms, then yes, obviously it does. But I don't frankly think that global investment banks are going to be any better off with a crisis like this. Eventually this is going to roll around the world, and that's actually what is beginning to happen already.
Zurich Centre Investments has just bought 24.1% of Peregrine. It will have a right of veto over "material capital transactions". Does this mean you have lost your much-cherished independence?
Not really. The parameters on which the capital restrictions arise are large enough for us to continue to do virtually everything that we've done in the past. So it's not a particular problem. They want safeguards against someone going bananas but it's not a significant problem at all.
Earlier this year you described a situation when Li Ka Shing phoned at 4pm and you committed to a HK$5.3 billion bought deal for Cheung Kong at 4.02pm. Will you need Zurich's consent for such deals in the future?
We would still be able to do that deal.
What is the history of the Zurich deal?
I first met Zurich about three or four months ago in New York when we were discussing a direct-investment fund. They were very interested in expanding their business in Asia, where they basically have nothing. We spoke about the direct-investment fund and then we began negotiating on what role they could play and how much money was required. That eventually came to the wire two to three weeks ago at the same time that all the problems were taking place in Asia. It became clear to me that in order to stop these rumours destroying our franchise completely we needed to put in place a shareholder - preferably a minority shareholder - of sufficient standing for our bankers to say: "Let's disregard these rumours. Clearly they are rubbish."
Do you agree with the ABN-Amro Hoare Govett analysis that you sold the stake at a 40% discount to Peregrine's book value?
A 40% discount to book value? Umh. Book value is probably around hk$11. This was sold at hk$8.
So is it another case of the Swiss getting a deal on the cheap?
Time will tell. I think the problems in Asia are far from over. Korea represents a significant danger not just to Asia but to the world. Japan has been completely inept in its handling of its crisis, which has been going on for seven years now. This is unfortunate because they are now not in a position to be of any significant assistance, whereas if they had done things right they would be.
I think Zurich have got a very good deal. I'm very confident in terms of our own business. I think that when we come out of this crisis, however long it takes - maybe it's a year, maybe two - we will be in a very strong position because I think a lot of our competitors will have dropped away.
How does this investment change the character of Peregrine?
On the positive side, we can point to having a large minority shareholder who clearly has an interest in coming into Asia in a major way. Zurich Group is in a variety of financial services sectors that we're not, such as fund management, insurance, reinsurance. They don't have an investment bank. That's where synergies will occur. The fact that they don't have an investment bank is reassuring for our staff. They will say: "You run it". It's not like an American investment bank buying you, and coming and imposing all their rules, regulations, systems on you. It's a very different situation.
Also on the positive side, I hope that by doing this we have settled once and for all the rumours about our so-called problems, which we have repeatedly denied - but which competitors and others have continued to say we have. We don't. Clearly Zurich would not have invested $200 million - having done a great deal of due diligence - if we had those problems.
How much due diligence did they do? Five days? Ten days?
Something like that. That's enough.
You have always trumpeted Peregrine's Asian-ness. Surely this makes the firm seem more European?
But Zurich is the biggest single investor.
Your critics could now say you're no longer the biggest independent Asian investment bank.
We are independent. We don't have a majority shareholder.
So you don't think this changes the character of the firm?
No. They've just made an investment. They're not putting anyone into the company.
They have a third of the board though.
So what. We don't run the company through the board. We never have, and never will.
The other rumour was that you were also looking for a Chinese investor as a means of balance. Is that true?
No. You have to ask: What are you looking for in an investor? You're looking for someone whom the [commercial] banks can look at and say: "Here is an institution that we understand. We believe that because of that investment, the credit quality and the risk parameters of our lending to that business are much more sound." That is key. As I kept on saying to people, we were - we are - a perfectly sound, profitable, functioning investment bank. But the rumours were killing us. Rumours were taking away credit lines. And members of credit committees that were sitting in New York or Frankfurt or Paris or wherever the hell they were would pick up a newspaper every morning and see Asia Inc implodes - again. You can imagine what they were saying. They were pulling lines, and saying reduce our risk to Asia. Not reduce your risk to Peregrine per se. Under those circumstances you need to have a shareholder who is visible and recognized.
But presumably they're stilling pulling their lines in Asia. Asia is still imploding.
Yes. But now they'll do it much less to us.
How long are the management lock-ins going to be?
I don't know. I haven't really thought about it frankly. Probably three to five years. That's fine. I'm not going to leave. This is my company. This is Francis's [Leung] company.
What is the size of your shareholder capital now?
At the beginning of the year we had $850 - call it $900 million. So $1.1 billion. Something like that.
At the time of the handover of Hong Kong, Peregrine was seemingly on top of the world - at least in Asia. A mere three months later the rumours in the market had you anything from severely crippled to bankrupt. Are there any lessons you draw from this?
Our competitors aren't very nice people. That doesn't surprise me. People are very jealous of us.
Do you believe in the expression there's no smoke without fire - that is, when it's not applied to yourself?
I would say normally that's correct.
So how do you explain the fact the rumours got to these levels?
Because most of our competitors lost much more money than we did, and they were trying to deflect the problems away from themselves.
But why choose Peregrine and not Jardine Fleming, for example?
We're much more of a threat to them.
How many institutions did the private investigators catch spreading rumours?
We have tapes of two, and know of others - but not on tape.
What would you say is Peregrine's single most successful business area?
I think our dominance of the China market. That's been very successful. We're still number one or number two in Hong Kong by stock-market turnover. Our fixed-income business has been very good. Actually most of our businesses have been very good. I have no complaints.
But is China the pre-eminent business?
Hong Kong and China is our home. If you're not in the top three in your home market, you might as well pack up and go home.
Fixed income is a capital-intensive business. Arguably, you don't have enough capital.
It's not so much capital-intensive. It requires a lot of funding. There's a big difference. Bank lines, swap lines all these things. That is what drives that business.
And hence what was causing you problems? Those lines were drying up?
No I don't think that was the rumour. The rumour was first of all that we had lost $300 million, and that wasn't quite enough, and then it was $500 million, then us$1 billion in either bonds or foreign exchange or something. No-one was quite sure what. We had a bond inventory apparently that was so large and so illiquid that it couldn't be funded. All this is rubbish.
If Asia wasn't imploding around us, none of this would be a problem. And of course the real nail in the coffin was when Hong Kong finally collapsed in October.
In the first six months of the year, the fixed-income division had a turnover of HK$64.3 billion, accounting for nearly 83% of the brokerage's total turnover of HK$77.7 billion ...
Don't get misled by those turnover figures. I hate those bloody turnover figures, which is why in the annual report we are going to try to report them differently. Turnover for agency stock brokerage just means commission revenue. For trading in equities - and obviously therefore for fixed income - where you buy it and sell it, it's the volume. That's why fixed income is distorted in terms of the
level of turnover that is reported in our accounts.
Unfortunately that is the way we have to report it because of Hong Kong accounting practice. If you look at last year, for example, we had actual turnover of about us$52 billion, of which about 62% was equity products. The balance was fixed income. If you look at our annual report you'll see a very different figure. Unfortunately it's one of those quirks of the accounting world.
In private some senior members of Peregrine blame fixed income for the firm's recent troubles. They feel that when you were just an equity house everything was fine. All this pioneering business in fixed income was a mistake. No-one knew how big the balance sheet was ...
Why should they know? What the hell's it got to do with them? Why don't they get on and do their business.
But they say none of the rumours would have started if it were not for fixed income. Do you agree with that?
Some of the rumours would not have arisen. But then if we hadn't run such a big balance sheet we wouldn't have had such a profitable business over the last few years. My guess is they would probably have attacked derivatives. One way or another, they would have tried to get us.
But we are not talking about people outside the firm now. This is a reference to those in the firm who feel equally sure fixed income is to blame.
Yes, but they don't understand the business.
It's a business that yourself and Francis Leung went into armed with very little personal experience.
We went into it because we thought it was the right thing to do. And nothing that we have seen would make us change our mind.
So you don't feel you've broken the golden rule: never invest in businesses you don't understand?
No this has been a very, very good business. It continues to be a very good business. Last year it contributed 38% to profits.
This year it will be lower presumably?
My guess is that this year it will probably be much more. But that would not be a fair way of looking at it. Obviously the derivatives business has lost money - well, is likely, to lose money this year. And that affects the whole equity-products division. Our agency stockbroking business has been quite good, particularly in the first half, primarily because of Hong Kong and Taiwan. But fixed income had a very, very good first half.
What is the average maturity of your portfolio?
Most of the stuff we deal in is one year or two years.
Is it all marked to market?
Everything we have is marked to market.
The question is, can you mark to market paper that can't presently be sold at any price? Who would buy six-month Indonesian corporate paper? There isn't really a bid in the market for it.
We don't tell people what we do. But we've moved a lot of paper. The fixed-income department is a very big overhead. You have around 250 people? Salary-wise they are probably paid - on the whole - less than equity people. Fixed income tends to be run much more along American investment-banking lines. Salaries are relatively low, and the bonus packages are relatively high. Therefore good producers earn significant amounts. Bad ones just get their salaries.
Do you not feel there is a problem of creating competing fiefs - equity versus fixed income?
I think that's excellent - a bit of competition.
But it's not good if you have a firm with internal animosities. That's not a good thing.
No. It shouldn't be animosity. It should be competition as to who can make the most.
Will Peregrine cut staff?
I think the industry will see massive retrenchment in Asia over the next six months.
We're part of this industry.