A few years ago, Thailand was not popular with foreign derivatives bankers. As the Thai baht went through a period of increasing volatility, regulators became more and more restrictive on the sale of derivatives, telling banks to submit lists of products they want to sell for approval. “At the time it was very annoying: I thought it was too draconian,” says one banker.

But Thailand’s stringency on derivatives paid off when markets turned really nasty. “In the two years or so before the global financial crisis, every new structure you wanted to bring out, you had to take it to the regulators to get an approval done for the product,” recalls Adam Gilmour, managing director and co-head of corporate sales and structuring for Asia at Citi. “That meant that by the end of 2008, when the crisis was at full steam, they had good practices in place: solid documentation, no speculation, and robust product risk they could feel comfortable about. It put them in very good stead for the crisis.”

The Bank of Thailand recognises derivatives are important for its companies – particularly with such a volatile currency – and so despite its stringency it has been gradually relaxing laws, most recently in August. The box in this article gives more details but in essence it widens the ability of companies, institutional investors and individuals to enter derivative contracts linked to foreign variables, be they indices, currencies or rates.

Thai derivative volumes are not large. Bank of Thailand data shows that in September 2009, total outstanding Thai baht interest rate swaps at Thai commercial banks came to Bt2,231 billion, or US$67 billion [CHRIS: THIS IS SOURCED FOM BOT DATA – DOES THE FIGURE SOUND HIGH TO YOU?]. While that sounds a lot, the Triennial Central Bank Survey, which compiles data on derivatives and forex from the world’s central banks, gives an indication of how Thailand really compares on a world scale: in its last published survey, in 2007, total average daily turnover of OTC derivatives market activity – including foreign exchange and interest rate – was US$5 billion, compared to US$210 billion for Singapore. Similarly Thailand’s reported foreign exchange market turnover – in total, not just derivatives – was US$6 billion, or 0.2% of the world’s total; Singapore’s was US$231 billion. One foreign banker puts it like this: “If I cut the universe [of Asian markets] into a top and a bottom half, Thailand would be in the bottom half, but near the top of it.”

Nevertheless, Thai officials consider themselves accommodative to derivatives, within reason. The Bank of Thailand describes its policy on derivatives to Asia Risk as “to accommodate development in order to make available as many risk management tools as possible, while ensuring financial system stability and financial institutions’ soundness. In other words, the challenge is to strike a balance between the flexible environment to foster innovation and maintain system stability.”

The bank says it is guided by five principles in formulating the supervisory framework for derivatives business: efficient risk management, appropriate to the nature and complexity of the business; financial and economic stability; sufficient customer protection; relevant prudential regulations being in place; and sufficient information for supervisory purposes. It also claims have put “considerable effort and resources” into education, human resource development, accounting standards and the resolution of tax issues.

Those in Thailand who watch the market closely consider the Bank of Thailand accommodating without necessarily being enthusiastic. “It’s a small market from an international perspective,” says Komkrit Kietduriyakul, partner at Baker & McKenzie in Bangkok. “But the Bank of Thailand has tried to support it –  they understand derivatives and believe they can be useful.”

Others find it can be bureaucratic, but works. “I’m very positive about Thailand,” says a foreign banker in Singapore. “There is plenty of bureaucracy, and it takes a long time if you want to do a new structure – getting it approved can take months. But it’s a lot better than a lot of other markets like Indonesia, where the industry shut down completely with the financial crisis.” He adds: “If I develop a new product, there’s a mechanism to take it to the Bank of Thailand and to be able to get it approved. They might be a little bit tight on the documentary restrictions, but there is a clear path.”

Most things a corporate would need to do, they already can. “As long as it is a hedging transaction, it’s basically OK for corporates,” says Komkrit. “What they don’t want to see is speculation by corporates, and the most sensitive issue is the Thai baht position for non-residents. Their experience in the last crisis [the Asian financial crisis] means they don’t want non-residents manipulating the baht.”

One could argue that the volatility in the baht makes it particularly essential for Thai companies to have access to derivatives since the penalty for not hedging a currency exposure can be severe. In particular, Thai exporters and importers are heavily exposed to the US dollar. The Bank of Thailand acknowledges that Thailand’s managed floating exchange rate and the global financial crisis “has led to more volatile exchange rates in the emerging market countries, including Thailand” and says that “hedging exchange rate risk is a necessity for Thai companies to protect themselves against volatility of exchange rates.” The Bank reckons it has “continuously encouraged” the business sector to hedge exchange rates, and hosts numerous seminars to help small and medium enterprises understand why and how. It also publishes an SME risk management manual. In any event, it says the recent relaxations have made it easier for companies to hedge, and to use foreign currency accounts.

What next? In November the Bank of Thailand issued its Financial Sector Master Plan Phase II, which covers a host of issues around the Thai financial system. Although the public announcements about the plan don’t mention it, people close to it say that it pledges to support the development of credit derivative transactions, as well as continuing to encourage interest rate derivatives and urging participants to use ISDA market agreements (which, in practice, they generally do anyway). “I think credit derivatives will become more popular in the Bangkok market,” says Komkrit.

For the Bank of Thailand’s part, it’s open to the idea of further openness. “We are supportive of the liberalization of the derivative regulation in Thailand, as long as the stability of our system is maintained,” says the Bank. But further change seems unlikely in the short term: “The current regulatory environment seems to be appropriate to accommodate the current level of market development and provide enough hedging instruments for our exporters and importers.” In other words, for now, it’s as open as they feel it needs to be.

Box: The August liberalization

On August 5 Suchada Kirakul, assistant governor in the financial markets operations group of the Bank of Thailand, announced a series of liberalization measures. Most were about investment in securities abroad, but they also had a significant impact on the derivatives market.

The changes were:

• Thai institutional investors – including companies with assets of at least Bt5 billion – are permitted to invest in securities abroad and undertake a range of derivative activities with onshore or offshore counterparties. These include derivatives linked to foreign variables such as exchange rates, interest rates, prices of debt securities, equity securities, commodities, and various indices. Transactions can be for hedging or yield enhancement, although derivatives related to baht exchange rates can only be for hedging. These transactions can cover up to US$50 million without the Bank of Thailand’s prior approval.
• Thai companies are given more flexibility in derivative transactions with domestic commercial banks to hedge their forex exposure. The BOT gives the example of hedging based on one-year forecasts of revenues or obligations relating to goods and services.
• Thai residents are allowed to invest in derivatives, structured notes and structured deposits linked to some foreign variables – such as indices – for yield enhancement and to hedge their investments in securities abroad.

What’s the impact? The Bank of Thailand tells Asia Risk: “The relaxation has provided alternative investment channels for the institutional investors so that they can further diversify their investment and enhance their investment returns through derivatives.” It has also helped institutional investors with their risk management by allowing them to hedge risks such as commodity prices and interest rates more flexibly and cheaply, the bank says. “Additionally, the relaxation has added more flexibility in foreign exchange risk management of Thai exporters and importers, enabling them to hedge their foreign exchange exposure more efficiently.”

At the individual level, residents have a greater range of investment products, while it also gives domestic commercial banks a chance to offer structured products to a much wider customer base than before. “More structured notes and deposits traded in the market could possibly help reduce transaction costs and add more investment products to the domestic market.”

December 2009

The Thai baht debt capital markets have enjoyed a year so vibrant it’s as if the global financial crisis never happened. According to ThomsonReuters data, by November 19, Bt304.36 billion had been raised in local currency bonds in Thailand in 2009 over and above government issuance – well up on Bt198.31 billion for the whole of 2008 and Bt182.73 billion for 2007.

“2009 has been beyond everybody’s expectations,” says Surabhan Purnagupta, head of investment banking at Bangkok Bank.

Why the increase? Part of the reason is a peculiarity of the Thai market: the power of the retail investor base. “Retail buyers have become very important players in the market,” says Surabhan. “They are seeking alternative investments to their deposits, as the bank deposit rate has become very low.  They’re becoming more and more familiar with corporate debentures.” Bank deposit rates plunged as the Bank of Thailand cut policy rates through 2008 and 2009, from 3.75% in mid-2008 to 1.25% by May this year, and although economists have started to project modest rate rises in early 2010, investors have spent much of 2009 looking for a better return than the 1.5% they can typically get for a two-year deposit with banks today. Contrast this with the 3.2% offered on the three-year bonds sold by PTT, the country’s darling credit, in April; or the 3.5% on two-year paper from Toyota Leasing Thailand, which is rated AAA, in February (although rates were still declining at that stage and had not bottomed). Corporate debentures have particular appeal since government yields on short dated bonds have fallen hard too, paying as little as bank deposits.

This marks a shift in the investor landscape. “It has changed a little bit,” says Thiti Tanthikulanan, capital market business head at Kasikorn bank. “In 2007 and 2008 it was mainly financial institutions who subscribed for bonds. This year it has been retail investors.  This year the credit spreads have been quite volatile, very wide at the beginning of the year but narrowing quite quickly as the year went on. So demand from financial institutions has been diverse and uneven.” Retail, needing the yield, has more than compensated.

Retail is easy to reach in Thailand: now that customers are familiar with the corporate debenture product, they buy the bonds in their local branches. On the day IFR Asia calls Bangkok Bank, it is the first day for subscriptions for a new issue of up to Bt8.4 billion in senior debentures for Charoen Pokphand Foods, for which Bangkok Bank is an underwriter. “Retail investors can just go to their bank branch and subscribe,” says Surabhan. This is one reason the primary market is vibrant but the secondary market lacks liquidity. “The people who invest in corporate bonds normally tend to hold them until maturity.” He reckons retail represents more than half of the market, and has been involved in some deals, such as the Bt12 billion multi-tranche issue for Skytrain operator Bangkok Mass Transit System in July, in which retail made up more than 80% of the deal.

This is also a reason that domestic bonds in Thailand tend to have a large number of lead arrangers – it increases the ability to reach as many retail investors on the ground across Thailand. PTT’s Bt35 billion issue in July, for example, credits 11 bookrunners – not just local leaders like Bangkok Bank, Siam Commercial Bank, Krung Thai Bank, Kasikornbank, Siam City Bank, TMB Bank and Bank of Ayudhya, but dedicated securities houses Thanachart Securities and TISCO Securities, and foreign-owned houses Standard Chartered Bank (Thailand) and CIMB Thai Bank. The sense is of using every possible avenue to reach the ordinary investor.

One also sees the retail influence in deal structure. Many of the biggest deals this year have come with multiple maturities. The Bangkok Mass Transit System issue, although it uncharacteristically had only two bookrunners in Bangkok Bank and Standard Chartered, came with five separate maturities – three, four, five, six and seven years. This was partly a retail strategy. “Normally in the market people say that if you issue three and four year tranches for sale at the same time, they cannibalise each other,” says Surabhan. “I didn’t believe that, and so we went out with three to seven year bullets and it proved successful. If you are retail and you want five years you take five, if you want seven you take seven; but if you want an amortising nature, you buy the three, the four and the five tranches at the same time, or all of them.” The strategy proved sufficiently successful to upsize the deal to Bt12 billion from Bt10 billion; not bad for a company emerging from restructuring and seeking to pay off hefty floating rate debt. “It was two times oversubscribed for a company that was only recently out of rehabilitation,” says Peng-Meng Ling, managing director and regional head of capital markets for southeast Asia at Standard Chartered. “It was a classic case of putting in the hard work in educating investors: after they learned to appreciate the credit they were willing to come back and invest in this paper.”

Some issuers have taken greater advantage than others in this environment, but none more so than the PTT group. In February the parent, PTT, issued Bt15 billion of eight-year paper. Another arm of the company, PTT Aromatics & Refining, raised the same amount in April, this time at five years. Then came PTT Exploration and Production in May, which raised Bt40 billion in the country’s biggest single deal of the year, in four tranches, at three, four, five and 10 year durations. So, seeing the attitude, the parent came back again: PTT raised Bt35 billion in July at three, seven and 10 years. In total, that’s Bt105 billion group-wide in five months – and more than one third of the national total for the whole year to date.

Unsurprisingly bankers consider the PTT deals the most significant of the year, “just because of the size of it,” says Thiti. “It wasn’t hard to do, because the name is so good and because at the time interest rates were quite low with not much prospect of recovery. So the bond was a very good alternative investment for financial institutions and retail investors.”

For issuers of PTT’s cachet, there is liquidity up to 10 years and beyond, though the bulk of corporate debentures come in the three to six year range. For lower-rated or less well-known issuers, access is tougher, though there have been signs this year of interest in names below the top tier. CH Karnchang is rated BBB+, and sold a Bt2.5 billion issue of three and five year paper earlier this year at rates that don’t seem excessive on a world scale: step-up rates from 5.3% to 6.3%.

One surprising thing about the success of corporate deals is that they have also had to compete with a sale of government savings bonds by the Ministry of Finance, that took Bt80 billion out of the market in mid July in a deal so popular it was fully subscribed within hours and upsized from its original Bt50 billion; and a Bt130.7 billion retail savings bond raising by Bank of Thailand in September, more than doubled from its original target, which attracted 60,000 retail investors. The Ministry of Finance may well be back again before the end of this year. 

Bank issues have been less noticeable, although they have been present: Krung Thai Bank raised Bt20 billion in February, and Kasikornbank Bt 600 million in a lower tier two issue. At the time of writing Thanachart Capital, a holding company for Thanachart Bank among other things, was due to launch a Bt10 billion five-year issue, and KrungThai Card, Thailand’s largest card issuer, was finalising a four and five-year raising. Other bond issues in the works at the time of writing were ThaiCom, formerly known as Shin Satellite; and Toyota Leasing (Thailand), a regular issuer in baht. One puzzling trait, though, is that the Bank of Thailand is believed to have refused approval for a number of foreign issuers in baht in recent months, although market participants seem to expect these approvals to be granted in 2010.

Quite apart from retail demand, there are other reasons it makes sense for companies to issue debt. “Most are trying to lock into the yield curve, with the risk of the BOT’s policy rate being either flat or rising in the coming months ahead,” says Somphan Eamrungroj at Export-Import Bank of Thailand. “Personally, [I feel] the yield curve has risen during the last two months too fast so may incur some corrections in the weeks ahead. The BOT has been passively trying to keep the policy rate stable amid their FX interventions to stem the strengthening of the baht, causing them to absorb the surplus baht out of the system.” Still, he says Thai Exim is “watching the market closely as we have some refinancing needs emerging in 2010.”

Additionally, the threat of the global financial crisis added an incentive for issuers to raise funds when they could. “At the end of 2008, a lot of corporates were concerned about the liquidity in the system and whether banks would still lend money,” says Thiti. “They saw what was happening in the US, where banks weren’t lending, and were afraid if that might happen in the Thai banking system as well. So corporates issued bonds to make sure they had liquidity going into 2009.” Then, with interest rates dropping through the first quarter, the attraction grew.

Has the surge run its course? “The pipeline is looking a bit thin at the moment,” says Thiti. “People who wanted to issue have already done so. Going into 2010 we think the volume will not be as large as in 2009.”

Still, the long term looks promising, and is attracting foreign banks despite the political uncertainty. CIMB pushed into Thailand when it became the largest shareholder in Bank Thai in 2008, rebranding it CIMB Thai Bank in May 2009. “The recently announced master plan [launched by the Bank of Thailand in November to cover the development of the financial sector over the next five years] placed a lot of emphasis on the bond market,” says Thomas Meow, head of debt capital markets for CIMB overall in Kuala Lumpur. “We believe there are a lot of opportunities there.”

Asian stock markets are suffering – even more than the US markets whose banks precipitated the credit crunch. While the S&P 500 index was down 12.2% in the year to August 18, Hong Kong’s Hang Seng index is down 24.7%, Singapore’s STI 19.9%, India’s Sensex 27.8% and China’s CBN600 an eye-watering 55.5%.

While the experience has been painful for investors, many feel that the decline represents a rare buying opportunity in Asia. There might be worse to come, but almost universally analysts and fund managers feel that investors with a long term view will be rewarded. The question is: where to pick?

The consuming issue of the moment is just what is happening to China. China’s economy is slowing, but all things are relative: it has slowed from 11.9% year on year GDP growth in 2007 to 10.1% in the second quarter of 2008, which by the standards of any other market is still breakneck speed. Even bears like Kenneth Rogoff, a Harvard economics professor and former International Monetary Fund economist, speak only of a “significant growth recession in China” to “at least one year of sub-6 per cent growth,” still dramatically higher than is routine in the developed world. The threat, though, is chiefly inflation, which hit 8.5% in April; on top of that, a US and European recession would clearly hit exports.

In the short term, some are still bearish about China. Stephane Mauppin-Higashino heads a product specialist team at Credit Agricole Asset Management, which offers a global emerging markets fund. His fund is overweighting Russia and Brazil at the expense of China and India. But looking further ahead, he has little doubt about the country’s prospects. “We believe the growth is here to stay,” he says. “Whether it’s nine or 10 or 11 or six, China will grow. It will average seven to eight per cent annualised growth through the cycle and we don’t have much of an issue with it falling below the trend, even to five per cent, if it were to happen.

“The issue we have had with China is the price: valuation, and inflation. It’s been a fantastic story but too expensive.” 

Some investors are also troubled by transparency in Chinese listed companies. Hugh Young is the managing director of Aberdeen Asset Management Asia in Singapore; he actively avoids most Chinese stocks. “At the company level, we really don’t have a clear view of earnings because of the lack of transparency,” he says. “Aside from that, so much depends on policy action: the level of stamp duty, the pipeline of IPOs, the release of non-tradable shares, and so on.”

That said, most foreign investors in China don’t go anywhere near the so-called A-share markets, which are domestic Chinese stocks listed in Shanghai and Shenzhen. Generally, they can’t, except through tightly controlled occasional institutional allocations from the Chinese state. Instead, they are more likely to invest in H-shares (Chinese companies listed in Hong Kong), red chips (Hong Kong listed and incorporated companies with substantially mainland operations and management), or Greater China plays – and in this regard Taiwan is looking increasingly interesting.

Taiwan has been a perennial underperformer over the years. “Over the last eight years the market has consistently disappointed, primarily due to policies that have encouraged capital flight,” says Adrian Mowat, chief Asian and emerging equity strategist at JP Morgan in Hong Kong. But when a new government was voted in on March 22, there was great hope of a change in fortune. President Ma Ying-jeou was elected on a platform that included a much more friendly relationship with mainland China than his predecessor, Chen Shui-bian. Ma will not push for independent statehood for Taiwan as Chen did, but will instead look for a better economic future for Taiwan predicated on greater freedom of trade, investment and general cooperation with the world’s most populous and vibrant nation.

An initial euphoria that prompted a 20% climb in the stock market in the run-up to and through the election has since unwound, partly because of the behaviour of world stock markets, partly because of the outlook for electronics stocks that dominate Taiwan’s economy, but also with a sense of reality about just what can be achieved in pro-China relations. Still, as CY Huang, the president for Greater China investment banking at the Taipei financial institution Polaris, points out: “Nobody can make magic in two months.”

And change is taking place. The iconic moment came with the announcement of direct flights between Taiwan and mainland China, albeit only on weekends. But there are more substantial shifts happening in investment and financial services. A long-standing limit on Taiwanese companies obliging them to invest only 40% of their net worth in China is being raised to 60%, and is likely to rise further. In June, limits were relaxed on the amount Taiwanese funds can invest in Chinese stocks. Additionally, an equally long-standing ban on Chinese investment in Taiwan’s stock and futures exchanges has been lifted: qualified domestic institutional investors, or QDIIs, which are Chinese institutions with approval from Beijing to invest overseas, will be permitted to buy in. Foreign mutual funds backed by Chinese capital can also now come in to Taiwan. “The government wants to attract PRC money to come into Taiwan,” says Huang. “Previously, you needed a declaration: if HSBC wanted to bring money in it would have to declare none of it came from China.”

Measures like this have two effects: they mean that Taiwanese companies are more likely to use Taiwanese banks and other service providers to handle their business, rather than moving the whole lot offshore to avoid restrictions; and they mean there is a greater chance of capital flooding into Taiwan instead of constantly leaving it. It’s this sort of momentum that has attracted Mowat at JP Morgan to make Taiwan one of his four major overweights in emerging markets today (the others being China, Mexico and Turkey). “Our argument is that during the DPP administration [under Chen] you saw capital flight and the government appeared to have no economic policy. The KMT government has come to power, liberalised investment restrictions for Taiwanese going into China, and has improved relations with the mainland.” Taiwan has three prongs for accelerating growth in the next year, Mowat says: tax cuts, infrastructure development and deregulation.

Elsewhere, prospects vary from market to market. (India is a whole other subject, beyond the scope of this article.) In southeast Asia, markets are struggling, whether through basic economics (Singapore, which being fundamentally a country of service industries suffers more than most when the US and other major trading partners run into trouble) or unusual specifics (the increasingly fractious political environment in Malaysia).

But the turmoil has created some unlikely opportunities. Global fund managers searching for a combination of low stock market valuations and high earnings potential might want to take a second look at Thai equities. The Stock Exchange of Thailand (SET) not only trades on a 2008 PE of 9 compared with 12.6 in Malaysia and 11.6 in the Philippines, but it offers a dividend yield of 4.9%. Better still, after years of dismal returns, analysts are forecasting that corporate earnings will increase by 21.3% this year and by 6.6% next year.

In its latest strategy report on the Asia-Pacific, Merrill Lynch rates Thailand as one of the cheapest markets in the region and suggests that investors overweight it. Merrill is not the only one with a buy on the market. Andrew Stotz, head of research at CLSA also believes that Thai stocks look attractive. “With the Thai market down almost 20% this year and with valuations looking the lowest in Asia, we believe that investors should be aggressively buying the market,” he says.

As is so often the case in Thailand, however, there is one major problem. And that’s the political situation. Few analysts believe that the coalition government led by Prime Minister Samak Sundaravej will survive the next 12 months let alone its full term in office. Furthermore, despite the recent decision by deposed former Premier Thaksin Shinawatra to seek political asylum overseas, the threat of mass street protests and a possible violent confrontation has not gone away.

Concerns over the fragile political situation together with fears of rising inflation, which reached 9.2% in July, have already dampened expectations for the second half of the year. The Securities Analysts Association recently downgraded its forecast for the SET Index to a range of 628 to 828. That compares with a current level of 702.

Still with the SET index having fallen by 20% since the beginning of the year and by more than 60% since its all time high in January 1994, canny fund managers will certainly find bargains. Asia Plus Securities suggests that investors look at property company Land & Houses, coal miner Banpu and energy giant PTT. These companies are expected to show impressive second quarter earnings as well as solid long term growth potential. Meanwhile Kim Eng Securities recommends select blue chips like Bangkok Bank, PTT Exploration and Production (PTTEP) as well as Total Access Communication.

So after the recent sharp correction in equity prices, has the stock market finally bottomed out?  Poramet Tongbua, head of research at Tisco Securities in Bangkok, certainly thinks that it has. “We believe that the market already reflects more than 80% of the worse-case scenario for political developments, rising inflation and higher NPLs. Consequently we are convinced that Thai stocks now offer an attractive risk to reward ratio for longer term investment,” he says.

Perhaps the best news for investors is the fact that for the first time since 2005, managers of listed companies in Thailand have become significant buyers of their own stock, suggesting that they believe that their businesses are undervalued. According to Phatra Securities, so far this year management of 47 of the SET100 companies have been net buyers of their own shares on a cumulative basis. That compares to only 28 companies where management have been net sellers.

To date, foreign investors have shown considerably less confidence in the market. Since January, they have sold off Bt86 billion (US$2.6 billion) of stock, representing most of what they had accumulated since the beginning of 2006. As a result, large capitalized companies like Advanced Info Services, PTTEP and K-Bank are at their lowest level of foreign ownership for at least three years. If and when foreign investors decide to return, Ian Gisbourne, strategist at Phatra Securities believes that these stocks could be amongst the star performers.

But whilst Thailand does offer some compelling reasons to buy, fund managers would do well to remember that this has been one of the worst performing markets in the region over the past decade. And whilst by most measures Thai stocks look cheap, investors will want to know that this time round, the market really will go up. Stotz for his part remains upbeat. “In Thailand, analysts are at the tail end of four long years of earnings downgrades. To us, earnings look much more vulnerable in China, Singapore, India and Hong Kong.”

In terms of sectors, three have been particularly badly hit in Asia. One is financial services, although banks in Asia generally had very limited subprime exposure. The others are real estate and gaming.

Here, too, there is ammunition for the bold contrarian. “People are going to make an awful lot of money out of real estate in the next couple of years,” says Mowat. “But at the moment it’s incredibly out of favour, particularly Chinese real estate. We think it’s oversold.”

Nobody has escaped. Take Capitaland, the Singaporean blue chip often considered the best run company in the country, the unquestioned leader in Asia’s fledgling real estate investment trust sector, and a true real estate blue chip. By August 19 it had almost halved in value in the space of a year. Ascott REIT, one of its trusts based around serviced apartments, looks even worse: well over $2 a share a year ago, 99 cents in August.

The fall in stocks like these reflects a number of dynamics. A slowing economic outlook reduces demand for high-end residential property and commercial property. Stocks that have used a lot of gearing – this applies to many REITs – have been particularly badly hit. But generally property related share prices have fallen by much more than the prices of the underlying assets, which causes some fund managers to see a buying opportunity – if it can only be timed right.

The pain has hit the region’s other developed markets too, notably Australia, which has the most entrenched REIT market in the region. “It’s been incredible, really,” says Andrew Saunders, CEO of Real Estate Capital Partners, a Sydney-based real estate fund manager. “The A-REIT sector was worth about A$145 billion in June 2007. Now it stands at A$70 to A$75 billion.” Saunders says some REITs are trading at as much as a 45% discount to net tangible assets, despite being underpinned in some cases by world class assets – such as Australian bank Westpac’s head office on Sydney’s Kent Street.

Arguably the chief attraction of this sector is the extraordinary yield. Australia is a high-dividend market at the best of times – CommSec chief equities economist Craig James says the Australian stock market today is paying its highest yield for 17 years, with blue chips paying as much as 6 or 7%, particularly in the banking sector – but the REIT sector is more generous still.

Fund manager Stephen Hiscock of SG Hiscock & Co in Melbourne says the sector has a forecast yield of over 9% for 2009, and 11% if one big and distorting stock, Westfield, is excluded. One fund manager calls it “potentially the buying opportunity of a decade. But the problem is, you know it could still all halve again tomorrow.”

The other big listed property market in the Asia Pacific region is Japan, which at the start of this year had a higher market cap in its REIT sector than the rest of ex-Australia Asia put together, at US$46.035 billion, though it has fallen since. There are 42 REITs listed in Japan.

Japan’s property sector generally has been hit by a credit crunch despite the fact that Japan had little exposure to subprime. 43 real estate developers filed for bankruptcy in July alone, mainly because they could not access funds. This, rather than the underlying properties themselves, has been the problem: at a time when Jones Lang LaSalle puts Tokyo CBD office vacancies at only 3%, relatively big names such as Urban Corporation and Ardepro have been badly hit by concerns about their ability to access credit.

Once again, there’s a question of whether falls create opportunities for investors. A recent report by Merrill Lynch said around half of all J-REITs are now trading below book value. They also pay what is, by Japanese standards, an exceptionally high yield of over 5%. And among listed real estate developers generally, those with the strength of balance sheet to ride out the credit crunch are likely to be well positioned and modestly valued by the end of it, and even in a position to acquire from troubled peers.

Already, several landmark transactions have taken place this year: CBRE Research highlights the acquisition of the Resona Bank headquarters in Otemachi, with Mitsubishi Estate acquiring a 73% sectional ownership of the building for Y162 billion. Others include GIC Real Estate, the property investment arm of the Government of Singapore Investment Corporation, purchasing the Westin Tokyo from a Morgan Stanley real estate fund for Y77 billion; Morgan Stanley Real Estate Investment acquiring the Citigroup Centre in Shinagawa-ku from Citibank for Y48 billion; and another Morgan Stanley acquisition, of the Shinsei Bank Building in Chiyoda-ku, for Y118 billion. REITs, too, have been acquisitive this year, with examples including Industrial and Infrastructure Fund acquiaring IIF Haneda Airport Maintenance Center for Y42.2 billion, and Japan Retail Fund acquiring Aeon Sapporo Hassam Shopping Center in Sapporo for Y18.4 billion.

Yuto Ohigashi, an analyst at Jones Lang LaSalle, sees opportunity. “While the type of real estate buyers has changed from high-leveraged investors to low-leveraged ones, the Japanese market remains attractive due to the sheer size of its investment grade property market compared with that of other Asian markets,” he wrote in a recent report. “Among Japanese real estate, Y490 trillion is held by corporations, about Y68 trillion of which is considered as revenue-generating properties. Part of the remaining real estate, which is valued at about Y420 trillion or more than six times revenue-generating real estate, is likely to be simply dormant, suggesting the enormous size of the potential market.”

The other sector to have been horribly hit is the gaming industry. Two years ago there was great fanfare and optimism in Macau. The state had opened up the gaming industry once dominated by Stanley Ho and awarded three concessions and a further three sub-concessions, bringing competition and money into a previously seedy sector. Groups like Las Vegas Sands, Wynn Resorts, Melco and Galaxy Entertainment had all committed considerable sums to casino development in the years ahead, and in terms of gaming revenue (as opposed to retail and entertainment in the same area), Macau has now overtaken Las Vegas as the world’s gaming centre. Many of the new ventures are very much in the Vegas style, combining world class entertainment and retail facilities with the traditional casinos, plus top-of-the-line hotels.

But if the share price performance in real estate looks bad, that’s nothing compared to gaming stocks. Consider Dore Holdings, which specialises in the VIP junket game, providing high-roller players to casinos. It has gone from HK$3.60 per share to HK$0.21 in a year – that’s a 94% fall. While not all stocks have suffered quite so dramatically, the situation has not been kind to anyone: when Sociedade de Jogos, the casino business owned by the ultimate gaming tycoon Stanley Ho, sought a Hong Kong listing, it took three years, more than 30 court cases, an application for judicial review on the eve of the float which caused half of the retail investors to back out of the offering, and a halving of the targeted amount to get away. And when it did, it promptly started sinking.

Part of the reason for the problems in Macau’s gaming industry are related to an apparent rethink on China’s part about just what it wants Macau to be. Over the course of this year it has introduced a number of measures designed to cool the growth of Macau’s gaming industry, to reduce the maximum length of time Chinese nationals can spend there, and to cut the frequency of their visits. Since the development of Macau is to a large extent based on the promise of China’s population, this has hit the industry hard. Increased competition is another concern.

But some consultants feel the future is much brighter than these headwinds would suggest, which again raises the possibility of buying opportunities. The Las Vegas based consultancy Globalysis estimates that Macau will experience 28.8% growth in gross gaming revenue (GGR) in 2008 year on year, to reach a total of US$13.5 billion. “It now looks like Macau will bypass not only the Las Vegas strip once again in terms of gaming revenue in 2008, but for the first time, also that of the entire metropolitan area of Las Vegas,” said Jonathan Galaviz, partner at Globalysis, in May when he launched his most recent report on Macau. “Macau’s continued growth in GGR is a reflection of the generally strong macro-economic environment that Macau finds itself within Asia.” If he’s right, then the sector is clearly oversold and presents opportunities.

A big question for the Asia Pacific region is what happens to commodity prices, which will have differing impacts in different locations. Of major markets, Australia is probably the one that has benefited most from the commodities boom: it is home (or a joint home) to world mining leaders like BHP Billiton and Rio Tinto, and its role as a quarry and breadbasket for ardent importers like China has led it to a stunningly protracted period of economic strength. Consequently Australia has not had a year of less than 2.5% GDP growth since the early 1990s, remarkable in a developed economy.

Australia’s market has been hit as hard as any this year though, and was down 21.4% year to date by August 18, partly as a result of market contagion spreading to the commodity sector. Those who believe the commodities boom has further to run tend to be more bullish on Australia than on other markets, although the short term is likely to be less favourable. “Given the relative important of resources in the Australian share market, Australian shares may underperform global share markets for a while yet as the commodity correction runs its course,” says Shane Oliver, head of investment strategy and chief economist at AMP Capital Investors in Sydney. “Asian shares are likely to be key beneficiaries of the correction in commodity prices given Asia’s high reliance on commodity imports.”

Asia, then, as ever presents a wide range of differing stories. Putting money into such volatile markets requires some tough nerves and a willingness to ride out some likely losses along the way. But, as one fund manager says: “Contrarianism is where the real money is made.”

 Intro

Dry bulk shipping operators completely dominate the top 10 for the transport industry – our monthly study of the Asian companies with the highest return on equity within particular market sectors. Airlines, airports and toll roads are nowhere, and even within the shipping industry there is barely a place for container operators. It’s all about dry bulk.

Bulk carriers are those ships that carry unpackaged commodities such as coal, ore or cereals. Part of the reason for their success today is because they are exposed to the resources cycle: more coal or iron ore being mined in places like Australia and demanded in places like China obviously requires more dry bulkers to carry it all.

One problem with ROE, though, is that it’s historical: the dominance of dry bulk carriers in our list reflects the fantastic environment of 2007, when the Baltic Dry Index – the established benchmark for the spot dry bulk shipping freight rate – climbed 122%. Towards the end of the year it started falling and by the middle of January was down 37% from its peak, and, although it has since rebounded, it appears to reflect a tougher market ahead.

Analysts say one reason for the sharp fall in the BDI was the market waiting for iron ore negotiations to be concluded, setting firm prices for what China, in particular, will pay for ore. This reflects just how much this sector is affected by the price and demand for the commodities they carry. Credit Suisse’s shipping research team rates a Chinese slowdown as the single biggest risk to its otherwise bullish view on the Asian dry bulk shipping sector. “A significant slowdown in China’s economy would lead to declining commodities demand,” says the broker. “This would impact upon shipping companies with vessel oversupply potentially leading to a sharp decline in freight rates.”

The price negotiations were a short term issue, though. A bigger concern is the extraordinary quantity of new ships on order. As the managing director of Thoresen Thai Agencies, Chandchutha Chandratat, explains on page xx, between 2009 and 2010 the size of the world dry bulk shipping fleet will expand by more than 25%, such is the volume of new vessels being delivered. In fact, Credit Suisse calculates that the dry bulk vessel order book now stands at 57% of the entire existing fleet. Many of the ships they replace will be scrapped, but not all, and this huge increase in supply cannot help but have an impact on freight rates.

A potential US recession won’t help, though it’s not the end of the world: dry bulk demand is driven by emerging economies (which have a more pressing need for raw materials). Credit Suisse calculates that trade flows to developed countries accounted for a still substantial 46% of major bulk demand in 2006, but points out that they only accounted for 21% of growth in major bulk demand from 2001 to 2007.

That’s not, though, the case for container shipping, which is driven by the developed world, which has more of a demand for finished goods. Here, the picture looks rather stark. “The sector is leveraged to the slowdown in developed economies, and 2008 could see oversupply due to weaker demand,” says Sam Lee at Credit Suisse. The only container shipping name in our list is the one at the very top: OOIL.

And where are airlines on our list? Only a budget carrier, AirAsia, makes the grade. Macquarie Research notes that both Singapore Airlines and China Eastern Airlines showed evidence of a slowdown in traffic growth and demand in their March operating statistics. SIA’s passenger load factor fell for three months in a row, but as Macquarie says, “the real headline is the 8.1 percentage point fall in passenger load factor on the North American routes.” It seems a slowing US economy is already having an impact in Asia. “We think that most of the poor operating data for the downward leg of this cycle are still to come,” Macquarie says.

Still, plenty of airlines are doing perfectly well: apart from AirAsia, double digit return on equity figures were logged by Malaysian Airlines, SIA, Cathay Pacific, Air China and Asiana, with Thai Airways just short. China Southern, China Eastern, China Airlines and Korean Airlines are the laggards. But spare a thought for Pakistan Airlines: its ROE came out of the Bloomberg machine at minus 375.2%. Room for improvement there, it would appear.

Thumbnails

1. Orient Overseas, Hong Kong: 73.8%

Orient Overseas (International) is a Hong Kong listed company active in container transport and logistics services, ports, and property development. Orient Overseas Container Line, its wholly owned subsidiary, is one of the largest transportation, logistics and terminal companies in the world. Property development focuses on China. Sold its terminals division for US$1.99 billion last year; even with that removed, net profit was US$553.7 million, up 29.3% on 2006.

2. Pacific Basin, Hong Kong: 69.8%

One of several dry bulk shipping groups on this list, again listed in Hong Kong. Operates a fleet of Handysize (shallow draft with onboard cranes) and Handymax vessels, which range in size from 25,000 to 60,000 deadweight tonnes. Specialises in the transport of minor bulk commodities, and handled 29.1 million tonnes in 2007, with coke and coal the biggest component. Young fleet, six years old on average.

3. Korea Line, 53.5%

Korean shipping group focusing on the transportation of energy and resources. Runs dry bulk shipping and LNG services through 28 vessels; runs a dedicated carrier service for Kepco, Posco and Kogas.

4. Thoresen Thai Agencies, Thailand, 37.7%

Another dry bulk group, this time based in Thailand. Also has an offshore services arm as well as some smaller service businesses. Listed its offshore services business, Mermaid Maritime, in Singapore last year; also achieved the rare feat of getting a convertible bond away in the early throes of the subprime credit crunch. See profile.

5. AirAsia, Malaysia: 35.5%

The only airline on our list is a Malaysia-based budget airline launched in 2001. Now flies to 45 destinations and has joint ventures in Thailand and Indonesia, with a fleet of 28 aircraft. Along the way has attracted funding from groups including Crescent Venture Partners; listed on Bursa Malaysia in November 2004; and signed a 130 aircraft commitment with Airbus.

6. HHI, Korea: 34.8%

Hyundai Heavy Industries is active in a range of industrial segments, but makes our list for its still-significant shipbuilding business, which is where HHI started in 1972. By 1974 it had turned a beach into the world’s largest shipyard; it has since become the leading world shipbuilder by deadweight tonnes. Separated from the Hyundai Group in February 2002. On January 1 it had a backlog of a staggering 471 ships, weighing 40.83 million tonnes; it will deliver 134 this year alone, more than one every three days.

7. Jaya Holdings, Singapore, 34.7%

Singapore-listed shipbuilder specialising in fleet owning and chartering, and shipyard operations. Specialises in small and medium offshore support vessels, such as tugs and other utility vessels, both as a builder and for chartering of its existing fleet for the offshore oil and gas, marine construction and mining industries. Has shipyards in Singapore, Batam and China.

8. Sinotrans Shipping, China/Hong Kong: 33.9%

One of China’s largest shipping companies. Owns a fleet of vessels and is active in dry bulk and container vessel time chartering and crude oil shipping services. Revenues climbed 22.1% to US$302.2 million in 2007, mainly thanks to dry bulk shipping.

9. Maybulk, Malaysia, 33.5%

One of Malaysia’s largest shipping enterprises, and one of very few active in international shipping through its own fleet. Owns dry bulk carriers and product tankers; also active in ship management and operates a container depot.

10. Precious Shipping, Thailand: 31.9%

Dry cargo shipping group listed in Thailand. Specialises in the tramp freight market – that is, one without a fixed itinerary or ports of call – and within that, small ships. Has 44 ships, unusual in this fragmented section of the market, and has 12 more on order between 2010 and 2013. Net profit in 2007 was Bt 4.156 billion, up from Bt3.715 billion in 2006.

ONES TO WATCH

Just outside the top 10 is Malaysian Airlines, one of the more remarkable turnaround stories of recent times. It was approaching bankruptcy in 2005, but under a new CEO and with the assistance of state-run Khazanah, it hit record profits in 2007. Its third quarter net profit, at RMB364 million, was up 52% year on year – and meant it had achieved the highest full-year profits in the airline’s 60 year history with only nine months of the year gone.

Another Malaysian stock, PLUS Expressways, is also just outside our list with an ROE of 25.3%. It runs tollways in Malaysia; traffic volumes were up 7.7% in the first two months of the year. Macquarie rates it outperform. “Given the stable and defensive nature of PLUS’ business, and the attractive dividend yield, we view it as an attractive investment in these times of high volatility,” says analyst Sunaina Dhanuka.

The highest ranked Taiwanese company is Sincere Navigation, ranked 12^th on ROE with 27.6%. Like so many on our list it’s a dry bulk operator. Credit Suisse rates it outperform.

PROFILE: ORIENT OVERSEAS

Our top ten is full of shipping companies, but almost all of them are in the dry bulk area, carrying commodities like coal or grain that won’t go into containers. Container shipping lines are conspicuously absent, with one exception – and it’s the name at the very top.

Orient Overseas International Limited (OOIL) , better known to most through its wholly owned container shipping subsidiary OOCL, is part of the fabric of Hong Kong’s recent history, and not just because of the profusion of ships that can be seen in Hong Kong’s waters carrying the OOCL logo. It was built by the Tung family: Tung Chee Hwa had to step down from running the company in order to become chief executive of Hong Kong Special Administrative Region for the handover of sovereignty from the UK to China in 1997. It was even the owner of the Queen Elizabeth when it sank in Victoria Harbour in 1972 amid efforts to convert it into a floating university campus.

Today, OO is in good shape. After the US$1.99 billion sale of its terminals division last year, it holds a net cash position – handy in a credit crunch – and achieved a 29.3% year on year increase in net profit, to US$553.7 million, in 2007 even discounting that sale.

Its impressive return on equity figures have a number of drivers behind them. Partly, it’s because of an excellent track record of picking the right time to buy new vessels, building the fleet when shipbuilding is cheaper. The resulting fleet is the youngest among OO’s peer group, with an average age of 5.2 years, which brings advantages in terms of reliability and operating efficiency. Owning the fleet is helpful too, given the effort the company puts into preventative maintenance: according to Stanley Shen, investor relations spokesman at OOIL, the total combined downtime from OO’s owned vessels for 2007 was just 256 hours, compared to over 3000 vessels for chartered vessels. “They [the ships the company owns] are hardly ever out of service and even when they are, it’s for a very short time,” he says. A new vessel was being delivered in the week of Asiamoney’s interview and a further 20 are on order between now and 2011, which will bring the proportion of ownership up and the average age still further down. And finally, there’s the IT system, which does not use a mainframe computer but instead works on client servers. This has been another source of efficiency gains: the company’s volumes have doubled in the last four years despite an only 5% addition to headcount.

That’s the good news. But the container shipping industry does face some challenges ahead. “One obvious issue in the short term is the oil price,” says Ken Cambie, chief financial officer. “The average price of bunker [shipping fuel oil] was about US$357 a tonne last year; in the first four months of this year the average would have been about $475, so almost $120 up on where it was last year.” This is obviously not a challenge unique to OO, and Cambie says this year is seeing “a united industry front in terms of recovering bunker costs through surcharges,” particularly on North American routes.

Then there’s the US outlook. Here, Cambie says problems were evident as long ago as 2005, when the US housing market started to slow, and says OO noticed a slowing of exports to the US throughout 2006 and 2007. “The industry has reacted in a very rational manner, with new capacity being added elsewhere to intra-Asia and Asia-Europe trade,” he says. “The profit on North America trade wasn’t that great in 2007 and the industry’s managed that already.” Still, exports from the US are doing well, driven by a weak US dollar, and trade routes that do not involve the US are seeing improving volume. For OO last year Asia-Europe volume grew 14%, and overall revenue by nearly 46% following an improvement on rates.

It is generally said that dry bulk shipping is more exposed to emerging markets, and container shipping more to developed markets. However, bulk shipping tends to be more volatile. Shen points out another major point of difference between the two models: bulk carriers go between a port of load and a port of discharge, carrying one commodity from one seller to one buyer. “On any one container vessel you might have 5000 customers, and you need to serve them all consistently,” he says. “It’s more like an airline. You need a well-oiled organisation to do this day in day out.” And this range of customers, while tricky to manage, is a defence against volatility.

Aside from shipping, the OO group has a property business, centred in China and with a particular focus on greater Shanghai. Having seen the terminals division sold, it is tempting to assume that the property business will go the same way in time. “I wouldn’t like to say we are going to spin it off, but what we are planning to do is get it to a state where the value of it can be better recognised,” says Cambie. The company has eight big projects underway in order to create a business with a continuous stream both of development and revenues. That has a couple of advantages: it’s a consistent earnings base to help counterbalance the more cyclical shipping industry; it makes it easier for analysts to value; and it creates the chance to sell it in future if the company wants or needs to. The cash from the terminals sale has proven very useful here, since one cannot borrow to purchase vacant land in China.

The company’s net cash position is really a one-off consequence of the terminals sale, but in the long term the gearing is likely to remain conservative: Cambie says he is comfortable with net debt to equity of up to one to one. In the meantime the cash balance may be helpful if other operators run into trouble and want to sell ships. “If it’s a more protracted global slowdown, holding quite large amounts of cash is helpful,” says Cambie. “It does figure in the back of our minds.”

PROFILE: THORESEN THAI AGENCIES

 Thoresen Thai Agencies has built a thriving business in dry bulk shipping and offshore services – one of Thailand’s only shipping businesses of note. It has been enjoying a great run. But can it keep it up?

Today, TTA looks in good shape. Its fourth quarter profit, at Bt1.159 billion, was a 34.5% increase on the previous quarter, driven by high utilisation and strong rates for freight. TTA is a market leader for bulk liner services between Asia and the Middle East, arguably the two most vibrant markets in the world: a good place to be. Its fully-loaded break-even on its shipping business – including everything from repair and maintenance to administration and depreciation – is US$7,000 per vessel per day; today it’s earning more than US$17,000. “I’d say 70% plus of our revenues for this financial year are already locked in,” says Chandchutha Chandratat, managing director.

But there are storm clouds ahead. “There are a number of headwinds emerging in 2009 and 2010,” says Chandchutha. “Various analysts agree on that, it’s just a question of the degree.”

One such analyst, Fearnleys, calculates that 127 million deadweight tonnes of new dry bulk vessels are expected to be delivered into the global market in 2009 and 2010 alone. To put that into perspective, the global fleet today is 395 million DWT. In other words, the fleet is going to expand by more than a quarter in just two years.

The demand side of the equation is robust, but surely not that robust. “Since this decade began it has been a boom for dry bulk shipping,” says Chandchutha. “On average it has grown by 6% a year. Our general belief is, with Asia still going strong, it should be able to trend at that kind of level through 2010. But with the huge amount of supply coming into the fleet, every analyst you read is projecting declining freight rates, probably in the latter half of 2009.” And being a leader on a particularly lucrative route is not the advantage it seems – since ships, obviously, are very portable. “That gives us consistent cargo volume, but what it does not do is insulate us from market pressures. If a lot of ships are trading the Pacific, there’s no reason those vessels cannot take up cargo right on our liner route. With potentially more open vessels in our trading area, we will of course get hit on price.”

The huge gap between TTA’s breakeven and its current freight margins will clearly insulate it, and it has another advantage: it is more diversified than some of its peers. In particular, it has built up in offshore services in recent years, which embraces a range of vessels from diving to firefighting but is particularly linked to the fortunes of oil and gas exploration. “We have made a very concerted effort over the past two years to diversify our business,” Chandchutha says. Its offshore services businesses are housed within a business called Mermaid Maritime. “When I joined three years ago, it was nothing in terms of revenues and profits.” Much has been done since then: Bt2.1 billion of equity was injected, assets were bought, people hired, and the resulting business was listed on the Singapore Stock Exchange last year. The result is a business with, hopefully, a different cycle to that of dry bulk shipping. “Even if oil prices fall quite a bit from existing levels, there will still be a very high level of production and exploration spending in the next five years,” he says. “So maybe in 2010, for example, shipping falls but we’ve got oil and gas picking up.” Since the IPO, Mermaid has ordered a new $136 million drilling rig, to be developed in late 2009, and some diving support vessels for delivery the following year (this alongside the nine ships on order for the dry bulk side).

Additionally, a shipping services business covers areas including ship brokerage to ship agency companies.

In the capital markets, it’s hard to fault TTA’s timing. The Singapore listing came before stock markets turned bearish, and additionally it managed to get a convertible bond away just as sub-prime started to bite, in September 2007. It raised US$169.8 million in a deal lead managed by Macquarie and Merrill Lynch – the only convertible launched out of Thailand in the whole year, and the second since the financial crisis of 1997. It took an unusual structure, with no put, and an amortising tenor with one third maturing at the end of each of years three, four and five. It featured a cash settlement option allowing TTA to redeem bonds for cash instead of stock in order to manage dilution. “And we issued the bond last year without any credit protection, which would be almost impossible today,” says Chandchutha. Its timing has been impeccable so far; will it remain so through tougher years ahead?

Just as Thailand has entered a period of rare political calm and optimism with a new prime minister, one of its most sickly banks has also been given a new lease of life with a landmark recapitalisation. But, just as the jury is out on whether Thailand’s government can build on its new foundation, it remains to be seen whether TMB Bank can turn the corner after years of underperformance.

TMB Bank was created in September 2004 from the merger of Thai Military Bank, DBS Thai Danu Bank and Industrial Finance Corporation. The merger created the (then) fifth largest bank in Thailand, and today has 471 branches and five million deposit accounts, but has struggled to generate performance to tally with its scale. It recorded a full year loss of Bt 43.7 billion in 2007, three and a half times worse than the previous year, and has non-performing loans equivalent to 15% of lending as of the start of the year, having set aside Bt31 billion in provisions last year for loan-loss reserve requirements and increasing bad debt.

In January, though, it completed a US$1.1 billion recapitalisation which gives it a chance to turn things around – this time thanks to the heady enthusiasm for Asian distribution platforms at ING, which took on 13.1 billion shares out of the 25 billion issued in the deal, taking it to a 30% stake (and 25% of the voting rights). The recap, advised on by Macquarie Securities, UBS and Phatra Securities, was something of an event in its own right: southeast Asia’s largest equity fund raising in the last 12 months and the second biggest since 2002, achieved in the teeth of the sub-prime crisis. And from TMB’s perspective, it considerably improves capital adequacy ratios and frees funds for investment.

TMB and its legacy businesses have long been stuck in the murk. Departing DBS chief executive Jackson Tai recently recounted to Euromoney the shocking state of Thai Danu when his predecessors at DBS agreed to take it over in 1999; it was so bad that it caused DBS to report a 13% NPL ratio at a group level – not just the Thai business – in 2000. Things haven’t greatly improved since and there is still debate about whether the 2004 merger made any sense anyway. (Among the dissenters is recently departed TMB chairman Somchainuk Engtrakul, who tells Euromoney: “I think it was not right. If you leave TMB alone in 2004, I think it would be in a much better condition [now].”) Somchainuk resigned after the recapitalisation, “because I have completed my role; it is time for me to hand the stock over to ING to carry on.” Chief executive Subhak Siwaraksa is expected to follow.

So what’s the appeal for ING of such an asset? Philippe Damas, CEO of ING Private Banking and of retail banking for Asia, puts it in the context of a broader strategy to build a distribution network in Asia.  From this perspective, TMB’s branch network looks appealing. “It’s a very nice imprint,” says Damas. “Obviously we also look at the current state, and we feel we have the experience to solve their problems.” Priorities at first will be governance, with wholesale changes at the board level and in management; improving the execution and systems for risk management; improving profitability, by driving revenues rather than cutting costs (“if you look at the net interest margin it’s pretty clear they’re at the bottom of comparable banks in Thailand”); and by increasing non-interest income, which fits in with ING’s broader expertise in insurance and asset management. ING will second between 15 and 25 people into the bank.

ING believes its experience in other Asian assets, notably ING Vysya Bank in India and Bank of Beijing in China, will set it in good stead. But rebuilding TMB will potentially be even more complicated than that.

For a start, there’s the fact that the Ministry of Finance, though slightly diluted in the rights issue, still holds 26% of the stock – less than ING, but more of the voting rights. Somchainuk says this level of ownership was never an issue under his watch. “The Ministry doesn’t involve itself in the day-to-day operation of the bank at all,” he says. “They have three representatives in the directors but they leave everything with the board and management. They are quite professional in this area.” But it still makes rebuilding the bank politically sensitive, particularly since the team now in the ministry under the new government is not the same as the one who handled negotiations for the deal. Damas thinks the ministry is so keen for success it will remain friendly; “they have been called to recapitalise this company a couple of times already, so this will be the last time they want to do so. As long as we can demonstrate we bring something and can manage the company, I think they will remain a very silent partner.”

Another issue to resolve is DBS, who held a 16% stake in TMB through their pre-merger stake in Thai Danu. DBS declined to participate in the rights issue in January, and so ended up diluted to around a 7% stake. As Tai explained in November: “We decided early on that we could not go ahead with the recapitalisation unless we saw that we could really take serious control over the future of the bank. We felt that 16% was never-never land in terms of equity accounting or consolidation.” When it became clear it couldn’t do that, Tai declined to take part in the deal, and instead launched a rival bid, including Deutsche Bank, which was not selected. Tai says DBS “will be good shareholders and see what comes ahead in the future”, but that will now be a matter for DBS’s new chief executive, Richard Stanley. ING would be a willing buyer but in the meantime the overhang is hurting the stock.

Much depends on the outlook for Thailand itself. An election on December 23 ended 15 months of limbo after a military coup deposed Thaksin Shinawatra in 2006; Samak Sundaravej, representing a new party that looks an awful lot like Thaksin’s old one, is the new prime minister. “The money has started circulating and the outlook for Thailand will be a lot better in the coming year,” says Somchainuk. “The economy will have a much better stance.” Logically, that means stronger businesses, and less pressure on NPLs; and perhaps a brighter future for a beleaguered bank.