Distress spreads in South Korea; Template that relies less on leverage needed

April 23, 2013 5:44 pm

Distress spreads in South Korea

By Henny Sender

Template that relies less on leverage needed

For many years, Japanese business people believed their economic malaise lay in a cheap South Korean won, rather than anything intrinsic to their country. Once the yen depreciated, all would be well.

The Japanese definition of well meant that consumers around the globe would cease to buy Samsung goods and turn to Japanese products instead. Now their thesis is about to be tested.

Thanks to Abenomics, massive liquidity in Japan means corporate distress there is diminishing. International hedge funds that bet not long ago on the cost of credit insurance going up for the weakest sectors, such as shipbuilding and steel, have seen the cost come down instead – at least for the moment.

By contrast, signs of distress in South Korean companies are starting to intensify. The country successfully weathered the 2008 global financial crisis but five years later, it isn’t faring as well.In most places in the world, companies and households have been reducing their debt burden. But in South Korea, leverage still remains too high. The top 30 conglomerates have 1,000tn won ($893bn) in debt according to one recent study. In the second half of last year, four of the top 12 groups were unable to cover their interest payments from operating profit.

That burden falls unequally on a group’s constituent parts. At one big South Korean conglomerate, for example, cash flows from stronger activities, such as car parts, are supporting weaker activities, such as construction, according to a board member.

Things may not be as bad as the Asian financial crisis of 1997-1998 when housewives sold their gold to help the country’s finances, but it is worrying nevertheless. The distress is particularly intense in shipping, shipbuilding, construction and real estate, all of which are facing a severe credit crunch according to the Korea Development Institute.

Weaker conglomerates are already feeling the pain. In 2011, the number of companies filing for receivership was five times that of five years earlier, and things have worsened since.

The first big shock this time was the failure of the Woongjin group, which went into receivership in September. Woongjin, among the top 35 conglomerates in the country, was in every struggling sector, from construction and shipbuilding to a savings bank and solar energy.

The Woongjin shock in turn contributed to the capital markets freezing up, increasing the stress on other cash-strapped groups. Capital markets have been especially spooked by the fact that many ailing companies raised debt in the market only weeks before going bust. That has led to a crisis of confidence regarding local credit agencies as well.

Now worries are growing about the health of the banking system. Many savings banks have already gone bust and in recent months, regulators have forced more than two dozen to suspend operations. But today the major banks are also seeing signs of pressure. Net interest margins have dropped while non-performing loans have been inching up, hitting earnings which are expected to decline at double-digit rates in coming quarters. Officially defaults on loans to companies last year rose to 2 per cent for the first time since 2003.

But seven major banks established a sort of bad bank several years ago, which they capitalised with their own equity, allowing it to buy up some of their bad loans. One hedge fund analyst in Hong Kong says it borrowed money extensively in the corporate bond market, paying for the loans with a mix of the capital from its shareholder banks and the money it raised, potentially disguising the scale of bad debts in the system. That sort of uncertainty and lack of transparency is never a good thing.

In the past, South Korea has confounded the naysayers several times. But today, as economic growth slows everywhere, competitive pressures and a zero-sum mentality about currencies is becoming more intense. For both South Korea and Japan, exports have been the principal driver of growth and both seem dedicated to that model despite the headwinds.

To be sure, there are opportunities amid the distress in South Korea. MBK, the Asian private equity fund last year bought Coway, a water company from Woongjin, acquiring a lucrative asset from a distressed seller. But the real opportunity for South Korea lies in developing a new template that relies less on leverage, especially hidden leverage.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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