Book Review – Money Games by Weijian Shan

Time to take a break from Macro and write something different. Every year I take a weeklong trip with my teenage daughter doing something different. Last year we hiked a summit in the Himalayas. This year we walked the beautiful hills of Kodaikanal in the southern Indian state of Tamil Nadu.

I used my spare time to read a book – Money Games by Weijian Shan. And it was worth every minute! The book is a detailed account of Newbridge Capital’s acquisition of Korea First Bank post the 1997 Asian Financial Crisis. Below is a simple summary. The note is structured as a Table – One row as Key Learning (in the grey box) and the next row as the corresponding anecdote in the context of the book and the actual transaction (in the white box).

Since time eternity, the core reason of financial / banking crisis has been the same. Excessive leverage, perverse incentives and unsound credit decisions.

During the rapid industrialization of the sixties and seventies, the Korean government chose “winner” industries and companies to bestow favours on (the Chaebols). Banks lent unbridled to these companies with the assumption that the government will come to the rescue of these strategically important companies if they get into trouble. The Asian Financial Crisis put this assumption to the test.  

External borrowings are always a double edged sword. Used wisely, lower interest rates and tapping overseas savings when domestic savings are insufficient, result in accelerated economic growth rates. Used excessively and unwisely, the short term nature of some of these debt flows can cause instability and result in an accelerated economic downdrift due to the pro-cyclical nature of these debt flows.

The World Bank has pointed out that if Korea had relied only on domestic savings, its economic growth rate which was 8.2% between 1962 and 1982, would have been only 4.9%. At the end of 1997, as foreign creditors pulled back on lending, Korea experienced a severe liquidity crisis.  

Capital is hard to raise! But it is always available for the really good deals.

Prior to this transaction, Newbridge’s first fund had raised $100mn in capital. Newbridge Fund II ($400mn) was in the process of being raised. Yet, at the first meeting with the Korean bank regulator (which was effectively the Seller), the author felt confident enough to state “Capital is no constraint for us” when asked if they had the financial wherewithal to consummate a transaction as large as KFB.  

In Mergers and & Acquisitions price is undoubtedly a critical factor, but often times the transaction boils down to considerations far greater than the price of the target asset.

In the immediate aftermath of the 1997 crisis, the Korean government had already poured 1.5 Tn Won into the 2 troubled banks, Korea First Bank and Seoul Bank and was expected to inject much more as more loans soured. Tax payers money was obviously at stake. The Newbridge proposal gave the Korean government 49% economic ownership and hence potential upside once the crisis has passed and the bank turns around. The deal structure gave the Korean government the opportunity to partake in an upside scenario and hence help sell this deal to the general public.  

“Signalling” is a very powerful construct in finance. Often times “signalling” can have the desired effect without actually having to transact to achieve the same objective. For example, if the RBA states that it will hold its 3 year bond yield at 0.25%, it might not even have to transact much in the open market to hold that level. Speculators might be put off just by the “signalling” effect.

Newbridge signed an initial MoU with the Korean government to purchase KFB in December 1998. On January 1, 1999 S&P revised its outlook on Korea to “positive” and indicated a possible upgrade of its credit rating. Amongst the reasons it cited was the KFB MoU. S&P even cited the MoU as an indicator of the government’s willingness to undertake structural reforms. In a similar example, the author states that international reaction and the stock market’s reaction to Newbridge signing a binding Terms of Investment on KFB was positive. Korea Exchange Bank went up 12% on the first day post announcement and bank stocks in general were up 3%.    

Transactions involving the bureaucracy will inevitably be games of patience. The key is to understand underlying motivations of behaviour.

A large portion of the book is a detailed description of the negotiation process with the Korean bank regulator which had been entrusted the task of selling the 2 erstwhile jewels of the country – KFB and Seoul Bank. Selling the banks was necessary, not only because it was required as a part of the IMF bailout, but also because bringing in new foreign investors would revitalize the strategy and operations of the bank and reform some of the old banking and accounting practices that, to some extent, had led to the crisis in the first place. At the same time, situations like these are politically volatile and ultimately the government and government officials are answerable to the public.  

Marking loans to market involves a ton of subjectivity. As a result, it is hard to gauge the quality of a bank’s loan book by just looking at its financial statements and notes to accounts. (Needless to say, the reforms to banking regulations in the past 25 years have significantly whittled down this subjectivity)

Prior to the 1997 crisis, Korean accounting practices were rather loose on the criteria to mark loans to their market value. As long as the borrowers paid their interest obligations, the loans would be classified as normal – irrespective of the capability of the borrower to meet future payment obligations. During the transaction negotiations, the Korean regulators insisted on applying this outdated accounting practice. Even though they also had an eye on overall reforms to move to forward looking accounting practices more in line with international standards.  

Loan syndication is a very attractive business for banks. In the ideal scenario, a bank can underwrite a risky but well-structured deal and sell down its exposure to zero. And in the process, earn significant fees and some interest on the exposure held prior to selling the loan to other investors. However, banking history is littered with examples of syndications gone wrong for a variety of reasons.

In November 2000, Citibank underwrote an 800 Bn Won loan to Hynix. KFB joined the syndicate for 100 Bn Won, even though it was full up on the Single Borrower Limit to Hynix. The semi-conductor market collapsed in 2001 and the price of DRAM chips fell 90% in 2001. KFB was left stuck with its Hynix exposures and ultimately took $200mn in losses, almost wiping out the previous year’s profit. The CEO accepted responsibility and resigned.  

In most situations, full disclosure and transparency is always viewed positively by investors. This is becoming increasingly relevant in private equity as investor participation is broadening and even the retail investor is getting more closely involved in this asset class.  

As a non-public company KFB would not have to publish its annual reports. However, at the request of the Korean regulatory authorities, Newbridge retained KFB’s status as a publicly listed company even though there were no public shareholders and the share were no longer traded. Since the bank had been nationalized using taxpayers’ money, the regulators wanted to ensure full transparency. And most importantly, Newbridge obliged.  

Diversification or minimizing Concentration lies at the heart of almost everything from investor portfolios to bank business strategy. However, it can sometimes be a double edged sword as Goldman has figured recently with its foray into consumer banking or the way Standard Chartered Bank figured with KFB post its acquisition in 2004.  

KFB, prior to 1997, was primarily a corporate bank. That strategy had also resulted in concentrated lending exposures to a few large chaebols. Under Newbridge, KFB pursued an aggressive consumer banking growth strategy to transform KFB into a bank with a balanced exposure. By 2002, Korea was experiencing a boom in consumer credit. The total number of credit cards issued in Korea – that had a population of 38mn over the age of 14 – reached 105mn in 2002 ! Years later, the consumer banking exposures would pose significant challenges for SCB to manage.  

Outbidding competition to buy a company is not reason enough to celebrate. A deal is successful only upon generating actual cash profit – either by a successful exit or organically during ownership.

Newbridge acquired KFB in December 1999 and would finally conclude its sale to SCB in December 2004 – after having successfully transformed the bank, improved risk management practices and having ridden the wave of Korea’s emergence out of the 1997 crisis. Together with the Korean government, Newbridge had invested 1 Tn Won or $900mn in KFB and finally sold it to SCB for 3.4 Tn Won or $3.3Bn.    

Due diligence is the holy grail of any Investing, Lending or M&A transaction and sometimes it is prudent to simply pass on opportunities rather than compromise on the depth of diligence for lack of time or simply because the opportunity is being pursued by many suitors in a bidding war.

Newbridge began active sales conversations for KFB in September 2004, primarily with HSBC – which was the most likely suitor for most of the time up until KFB was sold in December 2004. It was only on November 10th, 2004 that SCB entered into formal conversations with Newbridge on KFB and before 2 months were over, the transaction had concluded! Did SCB really do adequate diligence on KFB or got simply pressured into buying it because it was fearful of losing it to HSBC? While KFB was a successful deal for Newbridge, it would go on to pose many more challenges for SCB. KFB’s large footprint in retail banking from the aggressive growth strategy pursued during the Newbridge days, its personnel severance liabilities and many such other issues would go on be nightmares for SCB for many years to come.  

And finally, Buy when others are fearful. And wait patiently and bide your time when FOMO is in full swing.

Newbridge undoubtedly made a sweet deal on KFB. However, the key point to note is that it was willing to risk it when most foreign investors were running for the exits. By the end of 1997, Korea was on the verge of default. Money was fleeing the country, forex reserves were down to just $9Bn – 2 weeks worth of outflows, the stock market had plunged 49% and the Korean Won had depreciated 65% against the dollar. In this backdrop, the author provides a statement by David Bonderman, Chairman of TPG in response to the author’s interest in pursuing the KFB deal : “The history of life is that well protected failed bank deals are an excellent way to make money if you can buy them at the bottom of the cycle”.     And, just to tie this back into our current world of financial investments, I wonder if this is the best time to buy risk assets??  

Below is a long term graph of S&P500 Historical LTM Price Earnings Multiple

Money Games by Weijian Shan is a gripping narrative of Newbridge’s acquisition of Korea First Bank in the aftermath of the 1997 Asian Financial Crisis.

It provides an end-to-end narrative from Newbridge’s initial expression of interest to acquire KFB, the incredibly long and frustrating negotiation with the regulatory and government authorities prior to completing the acquisition, the turnaround of the bank and finally its sale to SCB after a bidding war with HSBC.

Happy Reading and as always Happy Investing !

Not meant to be Investment Advice. Do your own research. Happy investing!

Shashank Sawant

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