For years Chinese property developers have had it easy. When China sought to spend its way through the financial crisis, developers benefited from the abundance of bank liquidity. More recently, they have benefited too from the vibrancy of the high yield bond markets and their thirst for China exposure. But are these markets drying up?

A host of Chinese developers have found success in the high yield bond markets this year. For example, in April 2010 two developers launched in considerable size in the same week: Yanlord Land, rated Ba2/BB, raised US$300 million in a deal through HSBC, RBS and Standard Chartered, and Agile Property, rated Ba3/BB, raised US$650 million through Stanchart, Bank of America Merrill Lynch, Deutsche and Morgan Stanley. Other PRC property developers to have raised funds have included Kaisa, Renhe Commercial Holdings and (on the equity side) Shimao Property.

Many considered these bond deals to be a sign of borrowers looking for alternative sources of funds following a tightening of bank liquidity in China, as the state has sought to rein in bank lending as part of broader austerity measures to curb potential overheating. In fact, that may not be the case.

“To be frank we haven’t seen much evidence that there’s a tightening of liquidity for developer companies,” says Jason Kern, managing director and head of real estate advisory for Asia Pacific at HSBC. “They still appear to have good access to relationship-type lending both from a domestic base and from international banks.

“I suppose the fear out there would be that at some point liquidity dries up, but we haven’t seen any sign of it thus far.”

HSBC is working on a number of high yield bond deals for Chinese developer clients, and an absence of bank liquidity is not being cited as a rationale by any of them. Instead, developers are using bond markets to diversify sources of funds and build new investor bases. “A lot of the issues we are working on are debut bond issues,” Kern says. “If you are a publicly traded PRC developer listed in Hong Kong, in the long term you want to make sure there is appetite for your bonds as well as access to banks in order to diversify your funding sources.”

There is, though, a sense that the easy money from the bond markets may be gone, for the moment at least. Surely before the Yanlord Land deal, Glorious Property postponed its own planned global bond. Issuance appears to have stopped post-Yandlord as the markets have become more volatile: a combination of the effect of the European sovereign debt problems, uncertainty about how China will handle austerity measures, and the amount of funds already taken from the market by the likes of Yanlord and Agile. Pricing on existing bonds has backed up, and bookrunners mandated to handle further high yield deals are simply preparing them to hit the market, not actively launching them, instead waiting for better conditions.

“You had a window of two weeks that saw US$2.4 billion coming out in one sector,” says William Pang, head of Credit Trading, Asia, at Deutsche Bank. “You have also had a very specific change in government policy that has negative implications on the business model of these real estate companies,” he adds, referring to measures such as limited access to second or third buyers of the same household, and potential city-wide limitations. “Together with that is the overhang of the European situation. All of this clearly has an impact and has created some headwinds.”

“But real money continues to have interest in this space, and given that this is a critical part of Asian high yield, I don’t see a dramatic adjustment to that medium term trend.”

Despite worries about overheating in Chinese property generally, investors do not appear especially worried about the credit quality of individual names. “For PRC developers as a whole, balance sheets are in fantastic shape,” says Kern. “There are probably only a couple of names where you could make an argument they have an overleveraged balance sheet. For the most part they have less than 100% net debt to equity, and many are self-financing with cashflow from actual projects.” They are, though, vulnerable to a drop off in sales volumes if they are protracted, though so far the yields on offer -  an 8.875% coupon on Agile, 9.5% on Yanlord, 11.5% on Renhe – have more than compensated investors for that risk.

In the loan markets, extremely large deals are being completed in the Hong Kong markets, including for developers with considerable China presence. Examples include Chengdu IFC Development, owned by Wharf Holdings (HK$8 billion five-year bullet); Sun Hung Kai (HK$10 billion, five-year); Sino Land (HK$8.8 billion); China Overseas Land and Investment (HK$5 billion); and Yanlord Land (US$400 million, three year).

However, while liquidity for big, listed names appears strong, it’s a different story for those Chinese developers who are pre-IPO. “Two years ago the trend was that everyone was looking for net asset value based on the land bank, so pre-IPO companies would borrow money to increase their land bank to get a better valuation in their IPO,” says Ruoyu Jiang, Managing Director, Credit Structuring at Deutsche Bank. “Now, although land bank is important, people are more focused on the ability of a company to generate cashflow and repay their funding. It’s fair to say the Chinese banks have basically closed. There still may be people looking at the property sector pre-IPO, but they are very selective.”

Finally, Shimao Property’s HK$1.96 billion follow-on offering in April – raised, through JP Morgan and Morgan Stanley, despite a profit warning – suggests a third option for developers: more equity.

Ever since Ma Ying-jeou became President of Taiwan in May 2008 on a platform of warmer relations with mainland China, the island state’s businesses have been enthusing about the benefits that should flow to them from this new cooperative spirit.

The logic is straightforward. Closer ties mean greater ease of access, which is good for tourism and transportation, and should lead to more business in general. In particular, the lifting of long-standing restrictions on investment in mainland China is not only good for Taiwanese investors and entrepreneurs, but ought to galvanise the financial services sector too as banks follows their clients in to new opportunities.

But two years on, much the same language – of promise, of opportunity, of the future – is being used as it was when Ma came to power. “We are on the verge of a major transformation,” says Victor Kung, President of Fubon Financial, but it feels like Taiwan has been on that verge for some time.

In fairness, the picture varies from sector to sector. In aviation, for example, the whole environment has changed beyond recognition. It is less than two years since the first highly symbolic weekend flights from Taipei to Shanghai took place – the first direct commercial services in half a century – yet already there are 270 direct services between Taipei and mainland China each week, with plans to double that capacity to more than 540. This is a vast difference. “It used to be that when I wanted to go to China I would have to fly in to Hong Kong, wait awhile, and transfer to another plane in the direction I just came from. I’d lose a whole day,” says one businessman. “Today if I get a morning flight I can be having lunch in Xiamen or Shanghai the same day.” In terms of business productivity, this marks a significant shift.

Tourism has also had a major lift from Chinese visitors, with a corresponding effect on hotels and real estate generally. These industries are the front line of what is hoped will be substantive changes, and many international fund managers are positioning their funds to take advantage. “Our biggest country position is in Taiwan,” says Peter Sartori, founder of Treasury Asia Asset Management, which runs chiefly Australian institutional money from its offices in Singapore. “We’re a believer in the relationship with mainland China. We think it has improved dramatically in the last couple of years, and we think that’s set to continue. The market hasn’t priced that in yet.”

But in the financial services industry progress feels rather slower. Since 2008, banks have been excited about the prospect of being able to open branches (or turn existing representative offices into branches) on the mainland. This should allow them to serve their clients who have long been going in to China without them; to help new local clients invest on the mainland; and eventually to take renminbi deposits and build a new sustainable business. Banks have for years watched 40% of Taiwanese exports, worth about US$100 billion a year, flow to China but have been unable to serve their customers in their needs on the mainland, instead watching that business go the way of Chinese or international banks. The hope is that this will all now change. But still not one Taiwanese bank has been granted a branch license.

“Everything is more difficult at the beginning,” smiles Kung. “But we do remain very hopeful that once we have a beginning, everything shall move quickly.”

Institutional Investor’s last Taiwan report, in September 2009, featured an interview with Financial Supervisory Commission (FSC)’s Sean Chen – the country’s chief financial regulator – in which he explained the challenges involved in his negotiations with China to build memorandums of understanding to govern banking, insurance and securities. “The most difficult question to answer is when,” he said then. But he did eventually succeed: the MOU was signed in January, and hailed as a landmark.

After that, Taiwan announced new local domestic regulations regarding Taiwanese financial institutions going in to China. But the implementation of these regulations was then held up in the Legislative Yuan, Taiwan’s parliament, for several months, and consequently the FSC has only just started accepting formal applications from local banks to open Chinese branches. The regulator has not set a timeframe for processing these applications, but Kung does not expect to see branches open any earlier than the third or fourth quarter of 2010.

Even then, though, the impact of that breakthrough will depend on still another piece of negotiation, the Economic Cooperation Framework Agreement, or ECFA, which is being hammered out between the governments of Taiwan and China. This is a monumental discussion for Taiwan. “This agreement will set the framework, economically and politically, between Taiwan and China,” says CY Huang, co-founder and president of Polaris Capital. “It’s a very big thing. It will send a strong message to the world to imply a more normal relationship.”

There are numerous complex issues related to this agreement: the opposition Democratic Progressive Party in Taiwan believes it will lead to unification with China, which they fear; some feel it will reduce jobs and salaries and lead to outflows of capital and human resources; there are issues about migration of Chinese workers into Taiwan; and there are complex issues around tax, tariffs, investor protection and intellectual property to be resolved. ECFA is expected to be signed in June, but the whole agreement may yet have to pass through a public referendum before being implemented. It will be closely watched.

From the financial services point of view, banks are keen to see whether ECFA allows new branches to conduct business in renminbi. Under China’s agreements with the World Trade Organization, branches can only apply to do RMB business after three years of operations, of which two must have been profitable; Taiwanese banks are hoping they will be permitted to do RMB business from the outset.

Apart from commercial banks, other financial services players are watching ECFA closely. Eddy Chang, senior vice president of corporate strategy and planning at China Development Financial Holdings, a holding company that includes China Development Industrial Bank and Grand Cathay Securities, says the ECFA will help it to set up venture capital and private equity businesses in mainland China. “We would be able to set up our own office, and we could possibly raise RMB funds, whereas before we could only invest in US dollars.” Naturally, its potential investment targets will change too, to include mainland Chinese companies. Chang is hopeful that many Chinese local governments will invite CDFH to set up venture capital funds in China’s provinces, attracted by the group’s expertise in technology. “By doing so, they can attract Taiwanese high tech companies.”

While waiting for ECFA to be signed, several banks are already looking at joint ventures with Chinese securities companies or asset management businesses. But in the meantime, the most ambitious attempt by a Taiwanese bank to penetrate Chinese banking remains Fubon’s purchase of 19.9% of Xiamen Commercial Bank through Fubon’s Hong Kong subsidiary in 2008. “Last year was the first year of our investment, sending our team over to take over the management – it was a year of a lot of infrastructure building,” says Kung. “We made some organisational changes, tried to implement a new business model, and this year we will be able to start to build up our business more aggressively, especially for Taiwanese institutions in Xiamen and Fujian Province. This will be the year we are able to show some progress in numbers.”

Bankers describe the situation domestically as intensely competitive in Taiwan, but there are signs of enthusiasm from foreign players, again based on the promise of China. Peter Flavel, global head of private banking at Standard Chartered, is particularly enthused about Taiwan following a tax amnesty last year, “giving people an incentive to bring money that was offshore, onshore. There was quite a flow of money back into Taiwan.” Generally, he says, the Taiwan-China story is a story about trade. “Our wholesale bank will be involved in the explosion of trade flows – not just with China but in Northeast Asia – and trade creates wealth that needs to be invested.”

Certainly foreign brokers appear to believe risks are to the upside. Deutsche, for example, has a buy recommendation on each of Fubon Financial, Cathay Financial, First Financial and Yuanta Financial, saying “we expect further ECFA negotiations to support sentiment.” And Sartori says: “The economic benefits for Taiwan are too great for them to put roadblocks up. The Taiwanese economy and stock markets have lagged the region for about two decades because they’ve been hollowed out by Mainland China. We believe that’s changing.”

While banking is a key focus of China-Taiwan negotiations, there is more to the country than financial services. One of Taiwan’s economic mainstays has been technology and electronics, and here too there is a range of opinion: some think that the country’s semiconductor heavyweights like TSMC could be damaged by free trade with China; others are more optimistic. “There’s a concept called Chaiwan,” says Chang. “It’s Taiwan’s technology combined with mainland China’s market.” Certainly, there are some great believers in Taiwan’s tech story overseas. Robert Parker, special advisor at Credit Suisse Asset Management – which manages Sf1.3 trillion worldwide – says Taiwan is one of his key overweights in Asian equities, “because of the technology play.”

For many, access to China for Taiwanese businesses is only half the opportunity; the broader ambition is that Taiwan becomes a servicing hub to help people from all over the world move into China. “Taiwan is the perfect focal point between China and the world,” says Huang. “Taiwan knows China ethnically, culturally, linguistically.” And it’s a two-way street. “Chinese companies growing globally don’t have the right management capability; they could take minority stakes in Taiwanese companies and gain management talent. It goes both ways.”

For 60 years Taiwanese relations with the mainland have been fractious; yet now it appears Taiwan’s whole economic outlook is dependent on making the peace.

BOX: TDRs AND FOREIGN ISSUERS

Taiwan experienced a landmark on its stock markets on May 18 when Integrated Memory Logic, a Silicon Valley electronic chip manufacturer, listed on the Taiwan Stock Exchange – the first foreign initial public offering on the country’s exchange.

While the NT$1.4 billion offering, equivalent to just US$44 million, looks a fairly insignificant sum, this was a triumph for the TSE and its chairman Chi Shive, who has been pushing for foreign listings. IML chose Taiwan over Nasdaq and others because it had low listing costs, high liquidity and accommodative regulation, as well as being more suitable for a small listing than the Hong Kong or Tokyo stock exchanges.

As well as foreign IPOs, Shive has sought to boost so-called Taiwan Depositary Receipts, or TDRs. These generally involve Taiwanese companies overseas opting to raise capital at home, and once again they represent a play on renewed relationships with China. There were four of these listings from 1998 to 2008, then 10 last year and a further four so far in 2010; Shive hopes to see 20 this year.

The revival of interest has to do with a change in policy in which Taiwanese listed companies had a 40% ceiling on the amount of their capital they could invest in China. In that environment, many local companies – and all foreign companies – had little incentive to list in Taiwan since doing so would mean accepting a restriction on their investments in China, which over the last two decades has been an intolerable handicap. That cap has now gone. “The policy was originally designed to attract overseas listed Taiwanese companies to come back,” explains CY Huang at Polaris.

But the IML listing demonstrates that it’s done more than that, and illustrated the appeal of Taiwan’s capital markets for foreign issuers too. They are attracted by strong liquidity, making it a useful place for a second listing in order to diversify the investor base; and by high valuations, with many TDRs trading at a premium to the underlying share in the issuer’s home country.

Listings in Taiwan appear to work best for smaller companies – like IML – that would be swamped or ignored in bigger markets like Hong Kong or Tokyo. “Taiwan is the best market for small and medium cap companies,” says Huang. “In Taiwan the average IPO size is US$10 million to $30 million. You recently saw a cosmetics company raised $790 million in Hong Kong.” Taiwanese investors, he says, “are the richest, most open-minded and receptive. They love concept plays: there is huge liquidity for these offerings.”

Next could be Chinese companies. “Taiwan recently announced a new policy to allow PRC companies to list in Taiwan, so you have the potential for red chips as well,” adds CY Huang at Polaris. [In Hong Kong the term red chips refers to businesses that are legally domiciled outside of China, but in practice do nearly all of their business within it.] “All of these are a demonstration that the Taiwan market is internationalising and opening up, and the more it opens, the more competitive it will be. Taiwan is a new funding hub,” he says.

Yuanta was the lead manager on the IML deal, but this ability to attract foreign issuers – or to persuade Taiwanese who have listed elsewhere to return – is a source of delight to securities houses across Taiwan. “We hope Taiwanese companies that have listed in Singapore, Hong Kong and other places will dual list in Taiwan,” says Eddy Chang at CDFH, which includes within its holding company Grand Cathay Securities, another investment banking group that has benefited. “The government is encouraging these companies to come back and it has rejuvenated the capital market in Taiwan.”

Kung at Fubon – who says the pipeline for TDRs is “very strong” – thinks the rise of TDRs ties in to the drive towards Taiwan become a service centre for China. “Taiwan has certain advantages – for example it is one of the leading stock markets for electronics and technology-related companies – and I think it can expand on that by attracting technology companies not just from Taiwan and China but all over Asia to seek listing in Taiwan,” he says. “It offers the best valuations, the best coverage by analysts, and liquidity.”

Singapore’s economy has made a spectacular rebound in the last 12 month: it grew by a stunning 32.1% quarter on quarter in the first three months of this year. And this revival is being reflected in the city state’s financial job market. “I would say in banking the level of activity is up fivefold from last year,” says Elizabeth Goh, associate director at Charterhouse Partnership, the executive recruitment firm, in Singapore.

Goh says appetite is across the board but with selected pockets of intense interest, notably private banking – one of the areas hardest hit in the global financial crisis. “We didn’t see this level of interest even before the global financial crisis, when private banking was booming in Singapore,” she says. Strong candidates in these areas – which can range from pure finance to sales, back office to support – can expect “multiple offers, three or four, and the trend of recent months has been: may the best man win.” She says 40 to 50% increases on existing salaries are common.

Goh’s experience fits with the results of surveys looking at financial recruitment across Asia. 2010 studies by Ambition, the Australian-listed recruitment firm whose coverage includes Hong Kong, Singapore and China, show excellent prospects for those considering a move. Ambition reports that 74.9% of companies in Asia would consider hiring from overseas as the local talent pool diminishes, and more than 60% expect salaries will increase this year, with bonuses expected to be paid.

Asia’s attraction grows with every new European or American crisis. “Asia’s popularity as a career destination has continued to grow and throughout 2009 we experienced far greater numbers of candidates looking to enter this region,” notes Ambition, “as it is perceived to be one of the leading regions driving the global economic recovery.” Candidates from the US and UK have been in abundance, according to Ambition, though many without Asian experience have failed to make the transition.

What about the money? Ambition reckons a group CFO in banking or financial services in Singapore, with 20 years of experience, should expect to be making about S$600,000 a year; regional CFOs S$300-500,000 a year; head of audit or head of compliance from S$300,000 a year; and a senior VP for financial control, S$200-230,000 a year. These figures in the commercial sector tend to be lower: S$500,000 for a group CFO and S$200-350,000 for a head of audit, for example.

Both Charterhouse and Ambition report particular interest in the middle management level of financial control functions, and it’s no surprise that after the financial crisis positions in risk and compliance have been a big area of demand. “Now more than ever,” says Ambition, “the focus has been to attract talent that can act as a consultant to the business and add real value whilst performing a strong control function.” One red herring is ability in Mandarin: Goh says that although client-facing staff may find themselves more employable if they are bilingual, in most finance roles it doesn’t make much difference.

When Euromoney meets Alex Thursby, ANZ’s chief executive for Asia Pacific, Europe and America, the interview doesn’t take place in the bank’s Singapore office on Raffles Place but in a boardroom at local conglomerate Fraser & Neave. The boardroom is next door to the office of F&N chairman Lee Hsien Yang, who besides his chairmanship is the brother of prime minister Lee Hsein Loong, son of Singapore’s elder statesman Lee Kuan Yew – and, since February 2009, an ANZ director.

ANZ is giving us a message with its choice of interview location: that it is connected in Asia, committed, and a presence to be taken seriously. It’s a message that has been hammered home repeatedly for two and a half years since Mike Smith, a former HSBC executive, followed his appointment as ANZ CEO by unveiling a punchy and highly specific ambition to become what he calls a “super regional bank”, deriving 20% of its earnings from the Asia Pacific region by 2012 (it was 7% in 2007). Since that day, everything that ANZ has done – its appointments, the people it poaches from, its acquisitions, its choice of board representatives – has reflected that international and chiefly Asian goal. Even domestic activity is couched in Asian terms: when ANZ acquired a A$2.4 billion agribusiness loan book from AWB in December, an entirely domestic portfolio full of Queensland crop and beef farmers, Smith’s four sentences of formal comment in the announcement still managed to squeeze in a reference to synergies with Western China.

At a time when others have retrenched and reshaped, ANZ stands out for the brassiness of its ambition. Smith and Thursby are plain-speaking and strident. “We’re noisy people,” says Thursby. Smith speaks of a no-nonsense style of top management. “It’s very focused, it’s high energy, it’s fairly aggressive,” he says. “We’re certainly a straight-shooting bunch of people.”

ANZ’s straight-shooting is particularly striking since Australian institutions have not tended to expand overseas with such explicitly stated purpose – and when they have, it’s often gone badly. Australian institutional investors, who are a powerful force in a country with a more than US$1 trillion superannuation (pension) industry, are not in a rush to see their domestic champions dilute their earnings with speculative long-term growth strategies elsewhere in the world.

“Initially I got a fair amount of cold water poured on me,” says Smith of his initial super-regional announcement back in 2007. “Traditionally Australian investors saw the opportunity in the domestic market as being sufficient and there is a perception – I think a false perception – that Australian companies who operate outside Australia don’t do very well. Banks have tended to be very submissive to market sentiment.”

Smith is talking high above Melbourne’s Queen Street in the city where much of this institutional muscle resides. But for him, there’s no question where the opportunity is. A 29-year career at HSBC culminated with him becoming president and CEO of The Hongkong and Shanghai Banking Corporation Limited, which effectively means the head of Asia, as well as chairman of Hang Seng Bank and the head of commercial banking for the group globally. While by no means unfamiliar with Australia – he spent five years working there and two of his three children were born in Melbourne – he has been a globetrotter in the time-honoured HSBC style, managing everywhere from the UK, Argentina and Malaysia to Oman and the Solomon Islands. When ANZ appointed him CEO in June 2007, starting formally that October, they knew exactly what he would want to do. Thursby’s appointment, announced three days after Smith’s, underlined the ambition: another Brit (albeit partly schooled in Australia), Thursby had spent 21 years in senior wholesale banking roles at Standard Chartered, most recently in Singapore.

It’s not as if ANZ was unfamiliar with Asia before their arrival. Before either man stepped on board ANZ held 19.1% of Malaysia’s AMMB, 20% of Bank of Tianjin, 19.8% of Shanghai Rural Commercial Bank, 29% of Indonesia’s Panin Bank (now 38% plus an 85% stake of a subsidiary, PT ANZ Panin), had thousands of back office staff based in Bangalore and was probably the leading foreign bank in Indochina. But no predecessor had been quite so strident as Smith when, just two months into the job, he used the forum of ANZ’s December 2007 annual general meeting in Perth to outline the ambition to get 20% of group business from Asia within five years.

His announcement came just as the world was slipping into the financial crisis, and in that respect ANZ was well-placed. Firstly, Australian banks weathered the storm exceptionally well compared to their counterparts elsewhere in the world; secondly, it meant people and assets started to come up for grabs. ANZ has 5,500 people in Asia through organic growth; Thursby reckons 60-70% of them have been brought in in the last two years, by far the most aggressive hiring in the region through that period. On top of that, the acquisition of RBS’s assets in six Asian countries for $550 million, announced in August, brings the number to around 8,000. Are they still hiring? “Yeah yeah yeah,” says Thursby with enthusiasm. “I think we’ll be 10,000 people in Asia by the end of next year.”

While hiring on this scale can look scattershot, ANZ is actually quite clear on what it does and doesn’t want to be in Asia. It sets out three types of geographical approach. There are franchise builds, where ANZ wants to make large sustainable businesses: Indonesia, the Greater Mekong led by Vietnam, Malaysia through the AmBank partnership, Greater China, and India. Each of these will have an institutional, commercial and retail and wealth business. Hong Kong and Singapore will host institutional and private banking businesses with a modest retail wealth operation aimed at the top end, but will also act as financial hubs. A third tier of countries aims only for the institutional business – “the top 100, 120 clients in those countries,” Thursby says – including the Philippines, Korea and Japan. 

In terms of business lines, ANZ puts commercial and institutional together within a wholesale business built around rates, FX, cash management, trade and debt capital markets. Don’t expect to see ANZ turning into a broker in Asia, though: its only involvement with equities is in a derivatives business. “We’re not into broking, underwriting and so on,” says Thursby, who also says he won’t be into alternative assets, private equity, or M&A except where it helps existing customers.

Smith is big on knowing what not to be in as well as what to be in. “We don’t pretend to be a Wall Street investment bank and some of the businesses I inherited were trying to be,” says Smith. “If you play in the first division with a third division team the outcome is pretty inevitable.”

ANZ has been an active institutional presence in Asia for some time. But the most daunting area of what ANZ proposes is that it wants to build a retail and wealth business. Thursby describes himself as “a great believer in having a 50/50 business” in terms of the institutional/retail split.

This is a tough call – one could argue Standard Chartered still hasn’t nailed it after about a century – and Smith knows it. “We can’t do it fast. You can set up an institutional bank in six months, you put the people in and you’re there, but actually creating a deposit base is hard. I understand it won’t be a big business for a long time but it will be important, because that funding is going to be critical for the whole group.”

Thursby is keen to stress that this won’t be a retail bank competing on the ground for all deposits. “We have no capacity to enter the mass market,” he says. “I believe there’s only one international bank who can do it, and that’s HSBC.” Instead, in most markets he intends to focus on the top 3 or 4% of local individual wealth, with branches concentrated in the cities with the right demographic. In Indonesia, for example, “85% of the people we want are in four cities so let’s go and target those first.” It will be a business built around deposits and wealth management products (with an emphasis on distribution rather than manufacturing), with a niche standing in mortgages and a decent credit card business. “And, while I won’t be held to this day in day out, the trend will be two to one deposits to assets – three to one when you include funds under management. That’s a huge difference from the shape of an Australian bank which is predominantly mortgages, credit cards, and deposits are a lot less.”

If the model sounds familiar, it probably most resembles Standard Chartered: an unsexy but powerful wholesale business with a strong consumer element as well. Thursby agrees to a point but thinks ANZ resembles “the old Stanchart – they’ve moved into more of an investment banking model, whereas we are the wholesale model they used to be.” Certainly new hires have focused very much on Standard Chartered and HSBC (“and don’t forget Citi,” Thursby says): in the last two years general manager of Asia Pacific strategy Nancy Wong, China CEO Christine Ip and Korea CEO Heung-Je Kim have all crossed over from Stanchart, while chief risk officer for Asia Michael Denby is one of many HSBC alumni. “We have our own model and we are unique but there are parts of it that have a similarity,” says Thursby. “But we don’t have 150 years of incumbency. I’m like a new kid on the block with a technology company.”

While ANZ has been hiring on all fronts ever since Smith explained his vision in late 2007, it was the RBS deal that really demonstrated to the market how serious ANZ was about gaining scale. “It gave us a credibility in the region,” Smith says. “It said: these guys do mean business.”

The RBS deal brought in a range of business. The biggest was in Taiwan, where ANZ took on the retail, wealth, commercial and institutional businesses, covering 21 branches, 1.3 million customers and US$2.7 billion of deposits. The deal also covered retail, wealth and commercial lines in Hong Kong, Singapore and Indonesia, and institutional businesses in Vietnam and the Philippines; a total of US$3.2 billion of loans and US$7.1 billion of deposits (and this is key: as Smith says, “what I’ve loved about the RBS deal is that RBS sold us their funding base. That’s the hard thing to create”). It brings a client base of about two million people, at a price equivalent to 1.1 times book.

For Thursby, there were many advantages to the deal: it brought assets in countries where ANZ wanted to build; it was a declaration of intent; it was cheap; and it brought balance to his business by boosting that hard-to-build retail side. “I needed to get a kicker,” he says.

That said, one of the most interesting things about the deal was what it didn’t include. RBS’s China and India assets were on the block too, but ANZ bid for neither. CLSA analyst Brian Johnson told Euromoney at the time: “The premier assets RBS was selling were in China and India. What they’ve done is picked up the other stuff.”

Why? The explanation in China made sense: the assets were expensive and ANZ has plans underway. “At the prices they wanted there was no way we were going to buy China, and we can do it organically anyway,” Thursby says. ANZ has the two stakes in local banks, in which it would happily increase ownership if permitted; has 100% ownership of a rural bank it launched in Chongqing province last year, which while small is politically useful and sews the seeds for deposit-taking; and hopes to gain local incorporation for its own five-branch operation this year. Smith himself has the connections in China one would expect given his previous employer; he is a member of advisory councils for the mayors of Chongqing and Shanghai. Granted, ANZ’s 270 China staff at the time of the RBS deal were less than half the 580 it has in Vietnam, but there’s a plan and a presence there.

But what of India? For a bank with super-regional ambitions it seemed odd to steer clear of the Indian assets for the reason given at the time of the announcement – that it would be “a bridge too far”, “biting off more than we could chew.”

Eight months on, the two men differ notably in their explanations. Thursby focuses on the quality of the asset itself, and the ability to integrate with the small team ANZ has on the ground there (notwithstanding its Bangalore back office presence). ANZ at the time of the interview did not have an Indian banking licence, having sold its Grindlays franchise in the country to Standard Chartered in 2000. When asked if ANZ could have bought the assets even if it wanted to, Thursby says: “I wouldn’t have bought the Indian assets full stop at the prices they wanted. The business was caught between being a mass market business and an up-market business. It was a difficult sale, with some branches staying and some branches not; they had had a fallout generally in the consumer books; so I wasn’t interested.

“Also, could I integrate it? Did I have the people? If it was a perfect business I would have thought differently but it was a big ask for us to do it with no capacity. Mike and I both said we wanted to get a beachhead before taking on the market full frontal.” In Thursby’s account, the history with the Grindlays sale, and a long-standing dispute with India’s National Housing Bank that took a decade to resolve before being settled in India’s Supreme Court in 2006, were not really significant. “I don’t think it’s been a bugbear.”

By the time Euromoney met Smith in Melbourne 10 days later, the Indian banking licence had been pre-approved. Whether for this reason or others, Smith’s account is quite different. After emphasizing the need to behave sensibly and respectfully in India – “to be back is very important and we have to respect that we are a guest in India, to be cognizant of their feelings and to go at the pace they would like us to” – the exchange went like this:

“Euromoney: You must wish your predecessors hadn’t sold Grindlays.

Smith: Yes. In a word. Though the sale was loved by the market, I might add.

Did having exited complicate getting back in?

Yes. And quite understandably. For an organization to come in and out of a country is not ideal. Banking is about long-termism. You can’t go in and out and just expect people to understand because it’s commercially expedient. The commitment has to be greater than that.

If you had had the licence at the time would you have been more likely to acquire the RBS assets?

I would certainly have been in a position to have had a go, yes.

But you couldn’t without the licence?

I felt it would have been absolutely inappropriate to have made an offer without having a licence first. I think that would have been incredibly arrogant of us. I don’t think the Indian authorities would have perceived it very favourably.

Those assets are still out there, aren’t they? Could you still acquire?

Never say never. But right now we’ve got quite a lot on our plate. I would like to get to first base and then we may be able to have a look.”

Either way, India remains the missing piece of the jigsaw and an area where activity should be expected.

Is another major acquisition in the works? The bank is exceptionally well-capitalized with an adequacy ratio over 10%: even allowing for some fairly draconian changes in regulatory capital requirements, Johnson reckons “they can spend A$2.5 billion on just funding goodwill on an acquisition. There’s a sizeable warchest there.” Smith says: “We’ve got a lot of firepower, a lot of powder that’s dry.”

But analysts wonder if any of the good financial crisis opportunities are still around. “ANZ has got a capital level commensurate with a sizable acquisition, and that’s important to them; but the banking assets in Asia that are still on the market are becoming more expensively priced,” says Stewart Oldfield at EL&C Baillieu Stockbroking. “RBS was a good deal but was not the knockout blow some folk were anticipating in terms of size.”

Additionally, the speed and vigour of hiring has some people worried that the quality ANZ is bringing in is not universally high. Privately, executives at the banks who have borne the brunt of ANZ’s poaching say that the bank has made some good hires but also brought in plenty of dead wood. “They’ve hired a number of people. I’m not sure they’ve necessarily hired people of a stature that will really kick start their business,” says one, referring in particular to capital markets.

Picking up unwanted assets also presents an integration risk since the people within are not generally in the best frame of mind. Consider the Taiwan acquisition: four years ago most of its staff were working for Taitung Business Bank, which then failed, was sold in an auction to ABN Amro, passed on to RBS as a result of that merger, before being shifted on to ANZ. How will morale be there?

Smith acknowledges: “There’s always a risk. And a few will not be right, another few will fall by the wayside and ANZ won’t be right for them. But by and large the thing that has attracted people is that we’ve got a growth story here, a clear vision and agenda. And people want to be part of that.”

Thursby spells out the attraction. “We’re not looking at mid-tier,” he says. “We’re looking at the top three and saying: that is who we’ve got to challenge and survive against.”

BOX: NEGLECTING HOME

One of the biggest concerns domestically about ANZ’s Asian ambition was that Australia itself would be left behind. This was widely expressed when the policy was first announced in 2007 and it came back to the fore when the RBS deal went through. “In ANZ I see a bank that’s number four in the banking system,” Brian Johnson at CLSA told Euromoney at the time. “Asia is structurally exciting but ANZ needs to bulk up in Australia and that should be the priority.”

Since then, though, ANZ has won over some of its critics, Johnson included. ANZ used to operate in the vital wealth management area (probably the single greatest preoccupation of Australian banking in the last decade) through an unwieldy joint venture with ING, but bought out ING’s 51% interest in September for A$1.76 billion. “Our whole wealth management strategy was quite clearly dysfunctional while we had that joint venture in place,” says Smith. “We were half pregnant. You’ve got to be one thing or the other. And I think the global financial crisis allowed us an opportunity where we had a distressed seller to become fully pregnant. We are now in control of our destiny on that one.”

ANZ further impressed the market when it hired Philip Chronican, formerly CFO and group executive at Westpac, as CEO for Australia. Analysts seem to love him. “This guy’s absolutely phenomenal,” Johnson says. “I think we’ll see that business grow aggressively now.”

While the market seems less worried than it was, it’s still somewhat cautious. “ANZ still trades at a discount to the banks with larger Australian domestic franchises, and you’ve got to remember that under previous management ANZ also tried to expand in Asia and got warned off by its investors to some extent,” says Stewart Oldfield, analyst at EL&C Baillieu Stockbroking in Melbourne. “Australian institutions aren’t going to give Mike Smith the benefit of the doubt despite his formidable reputation in Asia unfortunately.”

Smith himself argues: “There was never any idea that we would stop investing in the domestic market. To me the core franchise we have is Australia and it would be absolutely insane to take that for granted or let it reduce. I just like the other stuff to grow faster.”

BOX: TOO BIG IN NEW ZEALAND?

If ANZ does become a super-regional bank, an Asian heavyweight with a core franchise in Australia, then one bit of it’s going to look mighty top-heavy: New Zealand, which generally accounts for 20-25% of group lending and deposits. “They are way, way too big in New Zealand,” says Johnson.

Asked if ANZ is too big in New Zealand, Smith says: “Would you want to be the biggest bank in New Zealand or the biggest bank in China? It’s quite an easy answer I suppose. But we are where we are.” The position has perhaps looked artificially bad recently because New Zealand’s economy has done so much worse than those of Australia and most of Asia. “The disadvantage of being the biggest bank in New Zealand was the last couple of years when the economy absolutely fell over. But I guess you could then argue it’s best in a recovery to be the biggest bank because you’re going to see the most benefit.”

But would the assets be better deployed elsewhere? “New Zealand can provide good annuity income,” Smith says. This annuity stream, at a time when a funding base is going to be important to ANZ regionally, seems to suggest a sale is unlikely. “But do I want to buy another bank there? Quite clearly no.”

To see this article in its published form, click here: http://www.euromoney.com/Article/2459515/CurrentIssue/74953/Banking-ANZ-shoots-straight-for-Asia.html

There were interesting developments in Malaysian Islamic finance last month, where a chief executive move provided a commentary on the rising power of foreign banks in Malaysia while also raising questions about their conduct.

In February, Jamelah Jamaluddin cleared her desk as chief executive of RHB Islamic, one of Malaysia’s leading domestic Islamic banks, and joined Kuwait Finance House (Malaysia) as chief executive.

It is the second time JJ, as she is known in Kuala Lumpur, has followed this particular path. She was chief operating officer at RHB Sakura Merchant Bank until 2005, back in the days before Malaysian banks’ Islamic arms were hived off into separate entities. She then moved to KFH when the Kuwaiti group became one of three Middle Eastern institutions to be given wide-ranging licences to conduct Islamic finance in Malaysia. She rose to be deputy chief executive there before coming back to RHB, this time as chief executive of its Islamic entity, RHB Islamic. Now she’s heading back the other way.

It is striking that one of Malaysia’s most senior Islamic bankers finds it more alluring to work at a branch of a foreign bank than to lead a much bigger domestic one. Granted, KFH is not just any foreign bank: it is the second-largest Islamic institution in the world by assets, and almost certainly the one with the most dynamic international mindset, with long-standing regional ambitions in Asia (the odd recent closure of a Singapore office notwithstanding). But RHB Islamic is hardly a tiddler: it was managing M$10.9 billion ($3.2 billion) of assets by June 30 2009 and has been among the fastest-growing Islamic financial institutions in the country, with regional ambitions of its own.

In Kuala Lumpur, though, few seem particularly surprised. A Malaysian-born head of a foreign entity in Malaysia says: “If I was put in the same situation and given the choice of either leading a much larger local outfit or staying where I am in a foreign house, I would stay, because in terms of personal development the opportunities are much bigger.”

Attitudes like this must give Malaysia’s institutions, particularly Bank Negara Malaysia, food for thought. On one hand, it’s evidence of success in Malaysia’s efforts to turn itself into a truly global hub for Islamic finance, attracting leading global institutions, if not yet any actual money, to Kuala Lumpur to do business. What might not have been part of the plan is foreign institutions coming in and stealing the top talent from domestic institutions rather than bringing in their own people: Malaysia has a skill shortage in Islamic finance as it is.

Responding to a Euromoney request for comment on the appointment, KFH (Malaysia) chairman Shaheen Al Ghanem replied in an email: “It has always been the intention of KFHKuwait to engage a local talent to head its bank in Malaysia, and we have found it in Jamelah…Puan Jamelah holds the distinction for being the first woman to head a KFH bank as CEO, representing a special milestone and significant breakthrough within the KFH Group.”

There are reasons Malaysia’s regulators may be happy to see a proven home-team player stepping into the KFH Malaysia top job.

When KFH launched in Malaysia, K SalmanYounis was seconded from head office in Kuwait City to Kuala Lumpur in 2005. He was well known and accessible, driving deals, outlining plans to build the business from niche areas of expertise such as air finance into broader investment banking, corporate banking, commercial and finally retail. He was instrumental in KFH’s attempts to buy a 33% stake in RHB’s overall parent, Rashid Hussain, which came with a commitment to invest M$12 billion in turning the group into an Islamic banking powerhouse; that deal was thwarted by Malaysia’s own pension fund, the EPF, which won the bid ahead of KFH.

But did Younis push a deal too far? Officially, he was recalled to Kuwait because projects needed his involvement there, in a decision that took formal effect on June 1 2009 when he relinquished his chief executive position. But the move was sudden, with leadership temporarily passing to a deputy, Ab Jabar Ab Rahman. And it has been noticeable that since Younis’s departure, a number of the property deals he was instrumental in have fallen apart. On Christmas Eve, for example, Mah Sing Group confirmed that a deal to sell part of The Icon@Tun Razak, an office development, to Prompt Symphony for M$237.1 million had been aborted because the purchaser had failed to pay the balance, forfeiting a M$42.7 million deposit in the process.

KFH Malaysia denies having an interest in the transaction but Euromoney understands Prompt Symphony is a special purpose vehicle 80% controlled by KFH entities. Six weeks earlier a similar Prompt Symphony deal, for The Icon@Mont Kiara, also lapsed. In another instance in December, YNH Property said it had been told by KFH that it would not go ahead with a 50% purchase of another Kuala Lumpur office tower, Menara YNH.

Is it prudence in the wake of the financial crisis? Perhaps, but that doesn’t explain KFH’s darkest moment in southeast Asia to date in early 2008, when it pledged to spend S$818.4 million ($518.4 million) on GucoLand’s Goodwood Residence in Singapore, then failed to go through with the deal, although it did later buy some units in the residence. This deal, under Younis’s watch, had raised eyebrows from the outset: S$818.4 million was about four times KFH Malaysia’s paid-up capital at the time and it has never been clear if head office in Kuwait had approved the deal – or, for that matter, the grand commitment involved in the RHB bid.

Insiders suggest KFH’s aggression in property investment had become a thorny issue in Malaysia, where prudence has been a watchword ever since the country’s banking sector reformed itself after the Asian financial crisis (notably, no domestic institutions got into any significant trouble in the global version a decade later). There are also suggestions that Jamelah’s departure from KFH the first time, and the departure of Raja Teh Maimunah, a rising name in Islamic finance who left her role as KFH’s chief corporate officer and head of international business without another job to go to in July 2008, reflected unease at the bank’s investment style and extension of credit in Malaysia. Raja Teh is now the head of Islamic capital market development at Bursa Malaysia, the stock exchange.

KFH (Malaysia) chairman Shaheen Al Ghanem directed Euromoney to the firm’s previous public statements on these transactions, offering no new comment beyond a statement that “it is part of KFHMB’s banking process and governance policy to have a constant and vigorous monitoring of all banking transactions to ensure that the bank obtains optimum value from all its transactions, especially in view of the changed economic environment”.

In this context Jamelah is a proven, experienced, safe pair of hands – and local. Her first job will be to give leadership and direction to a business that does, after all, have a lot going for it: chiefly one of the biggest chequebooks anywhere in the Islamic world.

“In some ways, a bank is just like a company that sells banana smoothies.”

Behold the most talked-about sentence in Australian banking. It comes from a three-minute animation sent to retail customers by Westpac in December in which the bank sought to explain rising interest rates on its mortgages by comparing it to the increase in Australian banana smoothie prices after Typhoon Larry.

Westpac is on the defensive after raising its mortgage interest rates by 45 basis points on the back of a Reserve Bank of Australia raise of barely half that, 25 basis points. But many customers have felt patronised by the animation, whose opening line is “once upon a time there were big lush fields of banana crops”, delivered in a voiceover one Australian commentator describes as “the manner of a Hi-5 presenter on Mogadon.”

It’s a rare challenge to CEO Gail Kelly, who has built her career on the power of banking brands and the ability to relate to the individual customer. The antagonism has spread right the way up to prime minister Kevin Rudd, who said he thought Westpac should take “a long, hard look at itself.”

The public reaction was not helped by coming out shortly after Westpac’s annual report revealed she earned A$8.48 million in the 2009 financial year including equity-based awards that vested during the year, rather more than one imagines Sydney’s banana smoothie vendors take home.

The headhunters who serve Asia’s banking community have mirrored their clients through the financial crisis. A severe plunge; an unexpected bounce; and a reshaping of the industry along the way.

“The business fell off a cliff for us in December and everything came to a grinding halt,” recalls John Wright at Global Sage in Hong Kong. “Everyone had to reorganize their businesses and shift people around; it took them a few months to figure out who was going to do what. But now we find ourselves massively busy – we had a record July.”

Other firms mirror that experience, and a few trends have arisen along the way. One is the seniority of hires and searches. In the good times, work tends to come in bolstering teams, or picking off star bankers in particular areas; over the last year, worldwide, so much of the change has been at the very top. “The biggest trend that’s happened is that very senior executive arrangements keep changing,” says Wright. And the institutions that have come through the crisis in the best shape are aggressive. “Firms who have got a good grasp on the future are prepared to consider and recruit the very best talent out there and take advantage of this time to bolster their business. As that restructuring happens, and as they get their liabilities under control, they are looking at how they are going to grow. Our clients are all looking at their growth plans and Asia has been the most robust region in the world.”

As the financial crisis unfolded, some interesting shifts took place. The most visible in Hong Kong’s corporate recruitment industry has been the bold growth of Heidrick & Struggles, which has hired some of the biggest names in the industry. Harry O’Neill, formerly of Whitney Group, came first, as head of Asia financial markets; next was the former head of Akamai in Asia, Daren Kemp; and finally, in probably the biggest surprise of all, Stephen McAlinden, a founder of Eban. Those who know the firm well point to the influence of Daniel Edwards, the mid-30s ultra-endurance athlete who heads the Tokyo office and is co-global practice managing partner for Heidrick’s financial services practice. “He’s the brains and the rock star behind the whole thing,” says one person who has dealt with him and the firm. “He’s going to be the next CEO of the company. His plan is to control 70% of the market so that H&S can dictate pricing.”

Asked what the relative strength of a global player like Heidrick is, Harry O’Neill says: “It’s reach, really, as much as anything else. The boutiques are very good at a local level, but the reality was that they had very good individual pieces of the business in the regions, rather than one good global business.” Additionally, for senior management or boards of major institutions, there is a certain safety in hiring a top five firm because they have the security of working with a high street brand and people are therefore less likely to be blamed for using them than if an experience with a boutique works out badly.

Wright at Global Sage also believes that scale has helped, particularly in an environment in which so many global firms are being overhauled, usually led out of the US or Europe. “I can’t stress to you enough how important having a global business has been to our survival,” he says. “Our ability to source all this information worldwide has given us an edge.” In the days before our conversation, JP Morgan, Morgan Stanley and UBS have all announced very senior hires globally – chief executives, investment banking heads – with ripples that will be felt worldwide.

Some feel that the big firms were better equipped than the boutiques to ride out the storm. Heidrick is one of the few listed headhunters so we know how that business did through the tough times: in the first quarter of 2009, ending March 31, it made a US$32.4 million operating loss, or $19 million excluding restructuring charges. The operating loss was US$11.6 million in the second quarter. This gives some illustration of the strain corporate recruitment firms felt in the first half of the year.

“It was an utter bloodbath. There was carnage in this industry in the first quarter and most of the first half,” says one headhunter. “Big firms can survive that but it’s much harder for a boutique.”

That said, while some boutiques have struggled and even fallen over the last 18 months, others appear to have flourished. The benchmark headhunters poll in Asiamoney magazine showed two lesser known groups climbing through the ranks, notably Matthew Hoyle Financial Markets, whose founder, Matthew Hoyle, was name the best executive overall in Asia. Similarly Wellesley Partners, set up only in 2005, has gained ground in a range of fields from investment banking to prime broking, fixed income and derivatives, with Christian Brun on the investment banking side an example of a rising star there, competing with established investment banking leaders like McAlinden, Wright and Executive Search’s Max Lummis. Of the boutiques that have suffered losses, Eban continues despite McAlinden’s departure, with Simon Waterson and Dionne Tai running the Hong Kong office; Whitney’s future was much darker after O’Neill left, with a major law suit between him, Whitney and Heidrick after his resignation. Whitney itself has since gone under (O’Neill took many of his Hong Kong team with him to Heidrick).

Asked what the selling point of a boutique is, banking specialist Christian Brun at Wellesley says: “Attention.”

“Our approach has been just working with a very small number of clients and doing as much as possible for them,” he says. Brun represents the opposite direction to McAlinden and O’Neill – he left the London office of Heidrick in order to set up a boutique. He’s known for being particularly closely connected to Credit Suisse, Morgan Stanley and Nomura, and the firm generally was very closely linked to Lehman Brothers, which had the consequence of making last year a much better year than it might have been as they moved people across to Nomura and replaced people who left afterwards. “Being a global firm doesn’t make any difference for a lot of the stuff we do,” he says. “At the end of the day it’s the relationships you have with the people at the top and the banking community generally.”

But some feel that the need for scale becomes more important as banks realise the need to make on-the-ground hires in mainland China and India, rather than just big-hitter bankers in Hong Kong and a couple of other hubs. “When you drill down into the key areas, China and India are the most significant,” says O’Neill. “In our previous lives, Stephen and I operated out of Hong Kong and Tokyo, Daren had a Singapore office, but none of us had anything in China, India or Australia. Now, we originate these searches here, and it’s Chinese consultants in China and Indian consultants in India who do the work with us.

“One of the features of this year has been that international firms are increasingly recruiting from domestic Chinese financial institutions – it’s one thing you really need to be on the ground to be able to do. Being able to approach candidates at a domestic level is very important.”

In terms of the money firms make, opinions differ on how much fee pressure there has been. At the top level, the point is not really the charge – typically varying between 25 and 33% – but the fee cap, which all firms agree to. “A head of investment banking in the region might be paid $7 million this year depending on what the firm is,” says one headhunter. “We wouldn’t get one third of that, we’d get whatever the cap is, perhaps half a million.” Others report that the money out there for senior hires varies, too: one says that Citigroup is offering multiple-year guarantees for some individuals, which is having a driving effect on the market.

“There’s an awful lot of hiring in China, natural resources and FIG – mainly senior strategic hires,” says Brun. “Next year’s going to be like 2007 again. We’re already seeing people being paid at levels I find amazing, right back up at 2007 levels.”

And, after all the turmoil, the retrenchment and the re-hiring, are there still good people out there?

“At a very senior level there are still good people out there – the very, very senior,” says Wright. And the process of rotation among that echelon may still have another round to go.

Japan’s banks, like most in the world, will end 2009 in better shape than they entered it. But they do so with considerable headwinds to confront. On the positive side, the biggest banks escaped the financial crisis largely undamaged and in some cases internationally transformed; on the negative, they face a great challenge to flourish in a deflationary country, and must raise billions of dollars in capital to bolster themselves for the future.

The latest round of results do show some promising signs for Japanese banks – or at least an absence of bad news. “We are getting out of the nightmare,” says Hironari Nozaki, bank analyst at Citigroup Global Markets Japan. “Symbolic is the credit cost. Last year it was 80 to 90 basis points, depending on the bank; for the first half of this year, it is coming down to 40 or 50 basis points. It confirms that the worst is over.” And in Japan’s case, “the worst” refers to a double hit: not only the global financial crisis but prior impairments on real estate companies. The bigger players reported modest increase in first half profits, with declines in client-related business being offset by growth in trading revenue.

It’s also true that Japan doesn’t appear to face a wave of distressed debt of the scale that some might have expected. “The Japanese banks have actually got a lot better at managing their credit risk,” says Graeme Knowd, banking analyst at Morgan Stanley. “The average corporate has much less leverage than they had in the past.” Nana Otsuki, banking analyst at UBS notes that the government has been strongly committed to supporting the small to medium enterprise sector, so “it’s in reasonably good shape. Credit costs may creep up in this business environment but we don’t expect a large increase in losses in this area.” And in terms of personal lending, Nozaki at Citi says that while some individual customers are requesting changes in their mortgage arrangements, “so far the deterioration rate is quite low. Japanese mortgages are much healthier than US mortgages.”

But while all that suggests no crisis ahead, that’s a long way from saying that the future is bright. The immediate problem is the health of Japan itself. “Banks don’t grow unless the economy is recovering,” says Knowd. “The general rule is that you’ve got to get nominal GDP growth back in order to get real growth at the banks.” Although Japan’s economy is improving, with 4.8% annualized GDP growth in the third quarter compared to declines of over 10% in the fourth quarter of 2008 and first quarter of 2009, it is still in a period of deflation, and “even the best managed western bank would struggle to make money in a deflationary environment,” Knowd says. “Deflation doesn’t help banks.”

It particularly doesn’t help lending. “It is not easy for Japanese banks to expand their lending domestically in a deflationary environment,” says Otsuki. On first glance, Japanese lenders look to have been very active: hence the fact that the rankings for global loan arrangers in the first quarter of 2009 looked like a throwback to the 1980s, with three Japanese banks in the top five and Mizuho at the top. But in truth that reflected a paucity of lending from European and American names at that time, now largely returned to the fold.

There’s demographics working against them too. Yoshinobu Yamada, banking analyst at Deutsche Securities Inc in Tokyo, adds: “In the long term, if banks are sticking with domestic loans, the prospects are not great because we are expecting a decline in population starting five years from now.”

Consequently, Japanese banks have increasingly been looking overseas for lending growth. It’s hardly been a surge overseas – 99% of Mizuho’s loan proceeds in the second half of 2008 were domestic, and 93% of Sumitomo Mitsui’s – but Mitsubishi UFJ, with 24% of lending directed overseas, is perhaps illustrative of the future. “Japanese banks have to lend or invest overseas, at least to an extent,” says Otsuki. That said, increasing capital requirements may curtail this expansion. “Two years ago Japanese banks were in a great rush to expand their overseas lending,” says Nozaki. “But because of capital constraints they are getting a little bit nervous about expanding overseas businesses.”

In that environment it’s very hard to find an obvious area of growth. Fee-based income, such as sales of funds and other products to retail, have been woeful, but this may yet swing around to provide a driver. Nazaki notes an improvement in the sales of investment products to consumers. “I feel some recovery here,” he says. “The first half clearly showed a bottoming out in sales.” Yamada sees the same thing. “In the medium term, one to two years, the recovery of fee income should sustain some growth in Japanese banks.”Generally, though, he is wary about the fact that recent profit improvements in Japanese banks have been supported by trading; rather than rely on that, he’d like to see Japanese banks expand in retail, not just at home but internationally, where so far only Mitsubishi UFJ (with Union Bank of California) has dared to tread. “The wholesale market all depends on the market, the economy. Japanese banks need stable growth and that comes from the retail market.”

And so all roads seem to lead to international expansion as an engine for growth – and in this respect, Japanese banks’ responses to the financial crisis were fascinating. One can argue that Mitsubishi UFJ’s agreement to take a stake in Morgan Stanley was the turning point of the entire global financial crisis, and it certainly represented a rebalancing of power in global banking. Similarly, Nomura had said before the crisis really took hold that it had built a warchest for acquisition in order to expand in the Asian region; its acquisition of Lehman Brothers’ assets in Asia came swiftly afterwards.

The Mitsubishi UFJ/Morgan Stanley alliance is still taking shape: it was only on November 18 that the structure of the securities joint venture in Japan was announced. “It’s a little too early to say if it was successful or not,” says Otsuki. Clearly it has great potential, but the usual puzzles about cultural integration will have to be sold for it to be a triumph. In the meantime, some analysts are playing equally close attention to the relatively forgotten Union Bank of California acquisition, thinking it could be a springboard to bring in further retail assets in North America. “They may use it as a vehicle to acquire regional banks in the future,” suggests Nozaki.

Particularly outside Japan, there is widespread doubt that Nomura can make its Lehman venture work, but most feel it is too early to make a fair appraisal. “There is scepticism that the cultures can be melded, but a sense of excitement that if it worked it would be the first truly global Japanese financial institution,” says one analyst in Tokyo. “If Nomura can show it can be done, maybe it will make some of the more aggressive banks sit up, take notice, and think: maybe we can do it too.”

There is domestic activity too. The big event of the year was probably Citi’s sale of its Nikko Cordial business to Sumitomo Mitsui, but another transaction may yet prove more significant: the merger between Chuo Mitsui Trust and Sumitomo Trust, announced in November, although the holding company will not be set up until 2011 and the two banks will not come under its wing until the following year. Analysts have been positive about this deal. “Sumitomo Trust is the best managed bank in Japan,” says Knowd. “They see higher capital requirements coming and realise you have to make a return on it; the only micro way of doing that within the control of the bank’s management is a merger that gives you cost synergies.”

“Fundamentally this is a positive move, especially given that they will be able to reduce their costs,” adds Otsuki. “If you look at a past example of mergers between trust companies, Chuo and Mitsui, their cost bases reduced by about 30%.”

So what next? “For the mega-banks we are close to the end,” says Nozaki. “But there may be more opportunity for regional banks to get together. There are 64 large regional banks.” He does see some prospect of the country’s two remaining independent brokers, Nomura and Daiwa, being attractive to the megabanks, in order to help them get closer to vital deposit bases, but it’s a moot point whether that would appeal to the independents themselves.

Overhanging the whole sector is concern about global regulation, and the likelihood that Japanese banks will have to raise vast sums in order to improve their capital adequacy ratios. The capital raisings are already happening: on November 18 Mitsubishi UFJ announced plans to raise up to $11 billion of common stock to improve its capital base. Mizuho and Sumitomo Mitsui UFJ are widely expected to do the same.

In Japan as globally, analysts mainly feel that global regulation is going to impede bank profitability. “With higher capital requirements and more stringent regulation it’s not going to be easy for the banks to achieve the same level of return on equity,” says Otsuki.

But not everyone thinks the capital raisings will be as onerous as the market seems to believe. Knowd argues the earliest one could expect to see capital regulation introduced to Japan is March 2013, which broadly fits in with the Basel timeline (which would require implementation by December 2012). Additionally, capital adequacy can be addressed not just by raising more capital but by reducing assets.

“It’s not that they won’t issue capital, but there’s a difference between being desperate to issue capital and doing so because you want to,” Knowd says. “Doing it because you want to, with consideration given to shareholders, puts a different perspective on how and when you do a deal.”

Nozaki at Citi adds: “Banks have time to think about capital raising. The share prices are very weak right now so it is not the appropriate time for them to think about it.”

This brings us to the issue of cross-shareholdings, rife in Japanese banks and corporate life generally. Analysts don’t like these cross-shareholdings at the best of times, but Knowd argues that selling them in the next few years would be particularly sensible since, by reducing assets, it would also help improve capital adequacy ratios. By his calculations, both Sumitomo Mitsui Financial Group and Chuo Mitsui Trust (in its pre-merger form) could move their core tier one ratios over 7% purely by selling cross-shareholdings; indeed, only Mizuho would need to make substantial further reductions in assets beyond selling cross-shareholdings in order to hit the 7% mark.

It’s already beginning to happen: Mizuho started selling down shares in the first half. “If Japanese banks accelerate their cross-holding sales,” says Yamada, “it should be bad in the short term for the equity market but good in the long term for Japanese banks.”

When you buy a credit default swap, you know what you’re getting: a derivative where you get paid if the underlying instrument defaults. Fine. But one of the curious spillovers of the global financial crisis is a controversy about who decides whether something has defaulted or not, and how they decide it.

This came to the fore in Japan in October over the fate of the Japanese consumer finance house Aiful. In September, Aiful said it would suspend loan payments and apply for alternative dispute resolution, and that it was in negotiations with creditors. This was enough for Standard & Poor’s to declare a selective default on Aiful, which naturally caught the attention of the many hedge funds and other holders who had credit default swaps with Aiful debt underpinning them.

On October 2, one of Aiful’s creditors, Aozora Bank, wrote to the determinations committee of the International Swaps and Derivatives Association. The determinations committee was set up to make binding decisions on issues such as whether or not a credit event (such as a default) has happened, and what obligations are deliverable. Aozora wanted the committee to decide whether a bankruptcy credit event had happened at Aiful, and also whether a restructuring credit event had taken place. (These events have different consequences for various different derivatives.)

ISDA’s Japan determinations committee came together on October 5, and dismissed both questions: the first because there wasn’t enough publicly available information to consider it, and the second because not enough committee voting members had agreed to deliberate the question. “This,” says one hedge fund manager, “is like saying that the committee decided not to answer it on the grounds that the committee decided not to answer it.”

Not deterred, another request came in to ISDA on October 15, again believed to be from Aozora, although this has not been confirmed.  This time, the request asked whether another type of default, called a failure to pay credit event, had occurred; the request was backed it up with supporting evidence suggesting that it had.

At this point, things started to get a little odd. Members following the ISDA web site saw two pages of Japanese text appear on the site, only for them to disappear shortly afterwards. The text, seen by Euromoney, gives details of repayments by Aiful, and appears to support the contention that it had failed to pay due debts.

So why was it taken down? Euromoney understands that ISDA put the documents on its site in good faith, only to receive a complaint from Aiful saying that the information was confidential and should not be published. ISDA duly took it down. But the real twist in the tale was that because that information had been declared confidential, ISDA’s determination committee refused to accept it. Consequently it rejected the question about whether Aiful was in default, despite the fact that it had already inadvertently published information appearing to suggest clearly that it was.

Those on the other end of the derivatives are furious – and there’s a lot of money at stake. According to data from the Depository Trust & Clearing Corp, contracts protecting $1.36 billion of Aiful’s debt were outstanding as of November 6, with as much as $238 million more protected through credit swaps based on indices that feature Aiful as a member, according to Bloomberg. Hedge funds and others who will get paid in the event of a formal default are furious. They want to know why it is that ISDA’s committee, having not only had evidence of a failure to pay waved in front of them but having published it online themselves, can then refuse to consider that information or even deliberate a question relating to it. They also wonder how ISDA can argue there is insufficient public information when Aiful itself put out a press release on September 18 – in English – saying it wanted to change the principal repayment schedules to its creditors.

At stake, hedge funds argue, is the credibility of the whole CDS industry, particularly in Japan. And that’s big business: Bank of Japan data shows that at the end of June, the notional outstanding of credit default swaps was US$887.3 billion.

http://www.euromoney.com/Article/2331913/Sri-Lanka-looks-beyond-euphoria.html

If you think a rebound in world stock markets improves your mood, try the end of a 25-year civil war. Interviews in the Sri Lankan capital of Colombo reveal a sense of unbridled optimism and opportunity.

“It’s a pivotal moment,” says Nick Nicolaou, HSBC’s CEO for Sri Lanka and the Maldives. “When a conflict like this is over – and you can look at analogies like Northern Ireland or Kosovo – the post-conflict scenario is one of great hope and an increase in economic activity and foreign direct investment. That’s the background that everyone is looking towards.”

The country’s major industrialists see the end of the war as one of the most significant developments in their recent history, in a business as well as a social context. “For us, it is going to be a complete change in the way we do business,” says Ajit Gunewardene, deputy chairman of John Keells Holdings, Sri Lanka’s biggest conglomerate and listed company with interests from plantations to food and beverage, transport, leisure, property, financial services and BPO. “The way we have done business for the last 25 or 30 years is no longer relevant.”

A few years ago, John Keells had become so big it had outgrown the country, partly because of the constraints imposed by the war, and so had begun a regional strategy. “We have now put all that on the back burner. We are focusing on the opportunities in Sri Lanka, and we believe those opportunities are going to give us better returns than what is available elsewhere. We expect the economy to grow at a minimum of 8% a year for the next few years: it’s not a complicated decision for us to decide where we should be.”

And it couldn’t have come at a better time – for as little as nine months ago, Sri Lanka was in a perilous situation. In recent years despite the war Sri Lanka has managed to keep its head above water and record annual GDP growth rates of 4.5 to 6 per cent. But by early 2009, with the global financial crisis and continued expenditure on the war having an increasingly damaging effect on the economy, full-year growth of around 2% looked more likely. Conflict was draining everything: the necessity for a vast armed force, fully equipped, in a nation that had once had only a symbolic force and could spend their money on welfare instead; lost potential from agriculture and tourism, which ordinarily would have been mainstays of the economy in the north and east where the war was taking place; use of the complex irrigation set-ups linking the dry and wet parts of the country, which ought to have benefited the east; the ability to exploit fishing stocks off the north and east coasts. “The war naturally brought a straight burden on the finances of the country,” explains deputy finance minister Sarath Amunugama, who is also the minister of public administration and home affairs (the formal finance minister title is held by the president). “But it also was a burden in terms of the potential we missed in the one third of the country that was inactive.”

And then the country went straight into the teeth of a foreign exchange crisis. Sri Lanka had permitted foreign investors to take up to 10% of government securities, but they almost universally pulled their money out early this year, as they did from most emerging markets during the worst of the crisis. “There was an outflow, not because of anything problematic in our economy as such, but because of what was happening elsewhere,” says Uthum Herat, deputy governor of the Central Bank of Sri Lanka. On top of that, movements in commodity prices had also depleted reserves. By March foreign exchange reserves had plunged to around US$1.2 billion – barely a month’s import cover – with almost all of the foreign holdings in the government securities market withdrawn.

Almost everything that has happened since then economically has been good news. History will probably judge May 18 2009 as the formal end of the war, as that is the day Velupillai Prabhakaran, the leader of the Liberation Tigers of Tamil Eelam (LTTE, or the Tamil Tigers), was killed, but it had been clear for some months that it was nearing a conclusion and it is really this realization that marks the turning point for Sri Lanka on a number of economic levels.

In July, after some months of negotiation and delay, the IMF approved a 20-month US$2.6 billion stand-by arrangement to support economic reform, US$322.2 million of it upfront with the remainder to come in quarterly instalments subject to reviews. “Without doubt, that has put a backstop on the foreign exchange reserves, and with that has come more investor confidence,” says Nicolaou. The same month, the sovereign took off around the world on a non-deal roadshow organised by HSBC and JP Morgan, and within weeks it had a clear illustration of how sentiment had shifted: a US$875 million investment in four- and six-year treasury bonds by a single US fund manager, believed to be a hedge fund. Total reserves now stand at US$4 billion, and the coffers will be further improved by a US$500 million global bond issue (see Euromoney, October 2009) which is in large part about putting a flag in the ground and setting a benchmark for pricing for the new, peaceful Sri Lanka.

So, with the fiscal position redeemed, what now? Where to start? Because, though the mood of optimism is tangible in Sri Lanka, there is much to do and none of it easy. Most obviously, there is a pressing need for basic infrastructure development, particularly in the country’s north. Donor funding will accommodate much of it, but obviously not the whole lot – and the government is committed under the IMF program to reducing expenditure, not increasing it. That means attracting FDI, which could require some level of reform in regulation and possibly tax, and in the meantime non-performing loans are creeping up worryingly – today 9% – in the banking system. Human rights groups have raised concerns both about the circumstances of the war’s conclusion and the displacement of hundreds of thousands of people into camps, which may have an impact on the willingness of multilaterals or donors to engage. And there are presidential and parliamentary elections to come early next year, although the president’s popularity is extremely high post-war. “On the one hand you have the euphoria: the huge possibility this country offers for transformational change in the next 10 years,” says Clive Haswell, CEO of Standard Chartered Bank for Sri Lanka. “On the other hand there’s some significant challenges that in the short term need to be managed, and the politics of the election process in the next six months as well.”

Infrastructure is the natural starting point. “That has lagged behind, because the war as consumed a lot of brainpower as well as investment dollars,” says Haswell. “There’s been a steady flow of soft loans and investments by a number of donor countries through this period but it’s still pretty slow in terms of building up the infrastructure of this country, and that’s going to be the main change in the short term.”

Herat at the central bank accepts that the costs of reconstruction will be immense, but makes two points. “Firstly we envisage much of the reconstruction will be funded by donor funds, or by funds at very concessional rates from multilaterals or on a bilateral basis,” he says. “To that extent the burden will be greatly reduced. But even it if it is a burden, it is something that has to be done. This is an opportunity we have not had in three decades and it must be seized.”

Minister Amunugama notes that the situation in attracting donor assistance is different to the reconstruction effort that accompanied the tsunami in 2004. “There was an outpouring of sympathy then, and donor countries were more than happy to contribute. Now it is not so clear, donors are not so unambiguous. But the humanitarian part of it is there.”

The second issue is the restriction on government spending. The IMF facility comes with several conditions. It seeks to reduce the central government budget deficit from 7% of GDP this year to 5% by 2011, by broadening the tax base, reducing tax exemptions and improving enforcement. At the same time it seeks to protect expenditures on social protection, improve bank supervision and restore the reserve position (which is surely already done). It doesn’t seem to leave a lot left over for roads or power.

Nevertheless, bureaucrats seem happy with the terms of the IMF deal. Herat at the central bank says he is “absolutely comfortable” with the conditions because “none of the conditions deviate in any way from Sri Lanka’s own policies. We have no qualms in agreeing to them.”

Herat says FDI has typically been US$600 to $800 million a year in recent years even during the war, and one can see it in the vast expansion of Colombo harbour, as well as a port and a power plant elsewhere in the country also being backed by foreign funds, particularly the Chinese. “I don’t want to put a number to things, but clearly if we can have $800 million FDI when the war was at its worst, it’s bound to increase.”

That’s going to be an important step. “In the immediate aftermath of the war we’ve seen a growth in appetite for investment in government securities. That’s really positive, but it’s not FDI in terms of building productive capacity on the ground, we’ve yet to see that,” says Haswell. It’s naturally going to take time to convince foreign money that this really is the end of conflict. “There’s a number of questions people will have from a risk point of view before we see a big step up in international appetite,” Haswell says.

That apart, there’s the broader environment for FDI. Amunugama points to widespread investment in areas like telcos – where Telekom Malaysia, India’s Airtel and Singapore Telecommunications (through Airtel) are all heavily involved in Sri Lanka – as evidence that the environment for foreign involvement, particularly through partnership, is attractive. 

But others think more could be done. Sri Lanka ranks 105^th out of 183 in the World Bank’s ease of doing business rankings, and is among the very worst ranked in terms of getting construction permits, registering property, paying taxes, and enforcing contracts. (On this point, each of Standard Chartered, Citibank and Deutsche are in disputes with various Sri Lankan entities about derivative contracts; these disputes are in arbitration and all parties declined to comment.) One institution highlights “the processes around legal recourse, around governance, issues of corruption, the huge taxes that get paid”, although the Board of Investments does offer mechanisms to give foreign investors relief from that.

Foreign banks are cautiously positive but aware of the challenges. “Next year you’ll see people dip their toe in the water but you do need to see evidence of change and the government is making the right noises about that,” says Haswell. At HSBC, Nicolaou says “the building blocks are there” and the board of investments is investor friendly, but highlights tax, which in the banking sector can hit 60% once income tax and VAT are considered.

So those are the challenges: what of the opportunity? HSBC is looking closely at project and export finance as infrastructure development gets rolling; even during the war it has facilitated over US$1 billion in finance in Sri Lanka in this area. “With ECA [export credit agency] cover becoming available we are expecting a flurry of activity in that space,” Nicolaou says.

The John Keells group says it is already seeing a difference, with agricultural production climbing and so prices of crops and seafood coming down. “The north and east was the rice bowl for the country,” says Krishnan Balendra, president of corporate finance and group strategy. “Prior to the conflict it produced 850,000 metric tons of various crops. Last year production was only 150,000 tons. Now there’s no reason we can’t get back to those numbers.”

Ajit Gunewardene says “tourism is obviously the quick win” post-war. Sri Lanka’s capacity is about 700,000 tourists a year, he says, and is likely to hit that very quickly, probably next year: in addition to the traditional markets of western tourists, the emergence of India’s middle class has made that the biggest provider of tourism. “It’s going to require a lot of investment to build new capacity. We should be getting to a target of 2.5 million tourists a year in four or five years time and that’s going to require up to 20,000 rooms.” Already the group is planning ahead, and is looking at three new projects next year: a brand new hotel on the west coast and two upgrades, one of them in east coast Trincomalee, which has been effectively out of bounds to tourists for years. The following year he expects to develop two more, including another in Trincomalee. Elsewhere, he expects property to be a boom area as falling interest rates prompt people to seek mortgages again.

For Rajendra Theagarajah, managing director of Hatton National Bank, one of the country’s leading banks, “we believe the bread and butter is to scale up fisheries and agriculture.” For that to succeed, he says, money is not enough: there needs to be access to markets, and storage facilities. Hatton’s approach has been to set itself up as a linkage between the buying power of its corporate customer base and the newfound sales capability of producers, “to make sure this is a win win for all of us.”

Hatton, like many others, is also looking with interest at the new funding opportunities that may arise from Sri Lanka’s improved visibility on the radar screen of international capital – something the sovereign bond issue will be very important for. “For the likes of us who have been clenching our fists and managing with internally generated funds for the last three to four years, we could look more optimistically at raising a different style of finance for growth,” he says. “A number of us have been showcasing ourselves beyond Sri Lanka. Now it is time to say there is a specific plan: come and back us.”

There is one caveat to the optimism, though. When Euromoney asked interviewees about whether they thought war really was over, almost all spoke about the obliteration of LTTE as a military force and the discovery of arms caches. Very few spoke about the integration of the different segments of Sri Lankan society, particularly Tamils from the north of the country, into everyday life, or redressing the issues that prompted people to fight or sympathise in the first place. That, surely, will be a challenge as important as any of the others this newly optimistic state faces today.

BOX: the stock market

Stock markets are always a useful barometer of a national mood, and the Colombo Stock Exchange is no exception: its All Share Price Index has doubled so far in 2009. On top of that, it’s also attracting IPOs.

The first post-war IPO was Hemas Power, with an almost Rp2 billion raising that was 3.7 times oversubscribed in September; another, Seylan Bank, was in the markets at the time of writing. More will follow. “We have some in our deal pipeline,” says Darshan Perera, chief operating officer of NDB Investment Bank, which led the Hemas Power deal. “The market is booming.” He says price earnings ratios are now around 13 times.

There is certainly room for more activity. “Only 200 companies are listed on the Colombo Stock Exchange out of 30,000 registered companies in the country,” says Krishnan Balendra at John Keells Holdings. “We think many more will list as valuations are becoming more attractive.”