Corporate Finance: When Monetary Policy Tightens

After spending 11 years with investment bank N.M. Rothschild, four years with HSBC and most recently three years with HVB/Unicredit, Quentin Amos joined Australia-listed mining and resources specialist Runge Limited last year as head of corporate finance and advisory for Asia Pacific.

 
He is thus uniquely placed to talk about credit and financing trends in the region from the prism of mining and resources. “My theory of money for projects is, if you want it, and you can get it, go and get it and don’t worry about pricing,” says Amos. “I don’t have a crystal ball so I don’t know what’s going to happen in the future. But if I’ve got a good strong project and I can finance it now, I’d take the money.”
 
On a recent visit to Hong Kong, Amos spoke to CFO Innovation’s Cesar Bacani about the credit and investment picture in Asia, the prospects for financing resources and mining ventures, and the way forward for the region.
 
Why are you here in Hong Kong?  
Hong Kong has a fabulous amount of money. It’s a prime global financial centre. And if it’s not the centre, it’s probably close to it because of the huge amounts of liquidity that are available on the mainland and available in the immediate region. It’s certainly a very exciting place to be. It’s a nice place to do business.
 
You are seeing a lot of liquidity still in Hong Kong?
The truth is, there is a tremendous amount of liquidity in this region. I will quote one of our clients here: “There’s one Louis Vuitton store in Paris; there are six in Hong Kong. Hong Kong Chinese go to Beijing to buy knock-offs; Beijing Chinese come to Hong Kong to buy the real thing, and they don’t buy one handbag, they buy 20 handbags at one go.” That’s liquidity.
 
But corporates do not necessarily have access to this liquidity, right? They need to go to the banks, which are still saddled by toxic assets, and financial markets, which are currently roiled by loss confidence in emerging Europe and tightening in China.
Prior to the global financial crisis, it was quite easy to go and get equity because everybody was throwing money at mining projects. And it was easy to get debt – the debt market was very strong and the syndication market was very strong. After the GFC, life changed.
 
The difficulty with debt-raising at the moment is that the syndication market that was there for 30 years has almost ceased to exist. Banks simply don’t have the confidence that, if they took on, let’s say, US$500 million of debt, they would find other banks willing to buy and sell down their position. In 2007, the core of banks [that specialise in funding mining projects such as HVB/Unicredit, Barclays Bank, Maquarie Bank, BNP Paribas and West LB] could have gone out to another 40 banks to support a big deal.
 
Those other banks would have said, “That’s all right, these people know what they’re doing. If we have detailed questions, we can ask those banks.” But now, those 40 banks have disappeared. They won’t do this business because they say that [mining and resources] are high-risk businesses that demand specialisation.
 
And lenders like Bank of America are laden with bad debts.
Bank of America [recently announced new provision of] another US$10 billion for bad loans. Now that really affects the syndication market. If Bank of America has US$10 billion in bad loans, how much has everybody else got? The general consensus is that there is something around US$2 trillion of toxic debt floating around [in the U.S.] . . . There are lots of rumours in the market place about certain banks. You talk to knowledgeable people, and you ask if this bank is OK, and they say, maybe, maybe not.
  

LENDING IN ASIA

But this is not true of Asian banks, which have not really binged on sub-prime mortgage loans and derivatives that are bringing down their Western counterparts.
The really active banks – ICBC, China Development Bank, China Construction Bank – these banks are the support for growing resources houses in this region. These are huge entities which can supply the money that we all need. I just think we’re really fortunate with the strength of the Chinese banking system.
 
You don’t believe there are hidden bombs there, with all this talk about asset bubbles in China?
I think, like any banks, there’d be bombs there but they’ll be dealt with in a different way. The desire, the necessity to keep China moving forward is extremely strong, and it really gives you confidence . . .  We in this part of the world are extremely fortunate because we got a dragon rebuilding itself and that’s a great thing. You can debate the figures left, right and centre, and we can talk about asset bubbles, but the reality is, there’s a really, really big economy, soon to be the world’s second biggest economy, sitting out there across the water, building a country.
 
We’re seeing Chinese companies coming [to invest in mining developments] in Australia. The most desirable part about it is, not only do you get the strength of your off-taker coming in, but they also bring a Chinese bank with them, which will finance the project and help it grow. Without that, if you were looking around and desperately hoping you’ve cobbled enough Western banks, you might have a syndicate with 50 banks in there, each one lending a small amount of money. That’s incredibly difficult to manage from an asset owner’s point of view.
 
But even Chinese and Asian banks, I imagine, have to look at how much risk they are putting on their balance sheets, given new regulations on the horizon and the Basle II international standard.
It’s an interesting question on Basle II. We know a lot about this financial meltdown and everybody talks about the loans people couldn’t afford to repay, and that’s true. But Basle II has to be another element. If you were pricing a loan at Basle I, and then you have to re-price it off Basle II, you might well [discover] a lot of assets that suddenly become [unviable]. The bank would go: “We can’t lend to this. We’ve got to get our money back.” So you turn up on the [creditor’s] doorstep, and you say, pay us our money back. That was a factor [in the credit crunch].
 
All these are crimping the banks’ ability to lend. On the other hand, central banks everywhere have cut interest rates to historical lows, although China, Australia and other countries are beginning to tighten monetary policy. Is it cheaper to borrow these days compared to before the global financial crisis?
Not if you’re a resources company. [Loans have] gone higher because of the control by credit and credit risk committees. They say that that style of business engages in more risks and [loans to the mining and resources sector] should be priced higher to [reflect] proper pricing of that risk.
 
At the height of the global financial crisis, those loans would have been priced almost two percentage points higher over LIBOR [London Interbank Offered Rate]. It might not be quite that high today, but it’s still lot higher prior to the GFC. Loans typically went up a couple percent, so for [the typical] XYZ copper company it might be, let’s say, [up by] 125 basis points.
 
There’s still quite a strong degree of resistance from credit committees because, at the moment, it’s more important not to lose money than it is to make money.
 
Is the pricing for mining loans typically higher than, say, toll roads?
Yes, because it’s anticipated that they will intrinsically be more risky. Pretty much everybody understands the car and everybody pretty much understands roads. Not many people actually understand the business of mining.
 
It’s very different from ABC Mining Company that’s just mining a small nickel deposit in Western Australia, for instance. The economics may look OK, but in that Basle II risk curve, it will be up around the 6+ level. Your internal cost of finance will be really high. Consequently your pricing for the deal has to be much higher, so that you’re actually making some margin.
  

FUTURE PROSPECTS

Do you anticipate that the cost of bank loans going forward will be much higher in terms of interest rates?
It’s an interesting question. Let’s look at China again. There’s a lot of anticipation of an increase in interest rate in China. In a country that strong, logic would dictate at some point in time that this would happen. And that will have an impact, probably globally, on the price of credit. It would have to put upward pressure on the price of credit because the willingness to lend money would be restricted again and it will be tightened and it’s going to force prices up.
 
And there’ll be a great concentration and desire to land at the bottom end of the Basle II curve . . . It’s not so much that I don’t want to lend money; it’s I don’t want to lend it here [in high risk projects]. And so the conversation [with banks] will be, if you can prove to us that our risk is very low, you’ll get reasonable credit. And you’ll probably get not a bad pricing. Anything with a bit of risk in it, pricing will be much higher.
 
The banks may end up simply buying government treasuries . . .
Ultimately you can’t make money doing that. It would be interesting to see what will happen in the States if they reinstitute the Glass-Steagall Act, where investment banks have to be pure investment banks. I think perhaps that is the way around a whole bunch of problems. So when you’re dealing with investment banks, you know the risk. You know they’re being creative, you know they’re doing a lot of exciting risky stuff. And you know that your housing loan is not necessarily at risk because of what these guys are doing on the more creative fourth derivative of the fourth derivative.
 
Do you anticipate the reinstitution of Glass-Steagall happening anytime soon?
I wouldn’t be surprised because what we see what the current incumbent in the Oval office doing is trying to tighten up to protect his shareholders’ money. And his shareholders are the American taxpayer.
 
But Glass-Steagall wouldn’t apply here in Asia.
No, it wouldn’t, but it would affect the world’s credit markets. If pricing goes up somewhere else, and I’m a bank, I’d think, “Hang on, why not ratchet it up 1%?” Logic tells me there will have to be an upward pressure. Until such a point in time as markets genuinely and truly recover, and that point in time might be two years, it might be five years, when they truly recover, things will go back to normal. But “normal” is not 2007. The pricing of risk became ridiculously low through 2006-2007. Banks weren’t making much money for taking reasonable risk at that point in time. It was in 2003, 2004, those are what we would call normal pricing of risk. You’re taking reasonable risks for reasonable rewards.
 
So is it a good strategy for a company, knowing that it has to fund capex in the next two years, say, to raise money now before loans become more expensive?
My theory of money for projects is, if you want it, and you can get it, go and get it and don’t worry about pricing. The reason for that is I don’t have a crystal ball so I don’t know what’s going to happen in the future. But if I’ve got a good strong project and I can finance it now, take the money.
 
Even though going forward the financing might become cheaper?
It might be, but there is only one rule in getting a project going. Get the money. That's it. There are no other rules. You just don’t know what’s going to happen in the future.
 
Even if it’s expensive today?
If I can normally finance a project to 2% and someone offers me 10%, that’s not a reasonable price. But please don’t debate between 2% and 3%. Ultimately that is not a smart thing to do.
 
Is this adage applicable only to the mining industry?
To business in general. We don’t have a crystal ball. None of us can see the future.
  

OTHER FINANCING

What about money from sources other than banks? I imagine you would be advising your clients to look at non-banks.
Absolutely. Most of our work is with funds and with private investment. We would be looking for funding for projects that would cost between US$100 million to US$1 billion to develop.
 
The environment in Asia is pretty buoyant. There’s a lot of interest in the mining sector.
 
Are mainland Chinese among those interested?
Much more so now than, say, ten years ago. If I have this conversation ten years ago, people would have said, if it’s not property, I don’t want to know about it. But now they do. They know that stuff’s been dug out of the ground, and people make money out of it. So there is a lot of interest.
 
And there’s a lot of liquidity splashing around.
There’s a lot of liquidity for the right projects. They’re intelligent investors. You have to be able to sit down and demonstrate what the facts are and you better make sure there’s a lot of facts. You can’t go in and have a small bag of goodies. It’s got to be a big bag, well-researched and well-understood. You must clearly demonstrate what the project is, what the steps are through the production and what the risks are, so the investors can price the risk for themselves.
 
Look also at what we would call the normal publicly listed funds, and also the unlisted funds, that bring money in not just from Asia. There’s a lot of money from the Middle East that ends up here [in Hong Kong]. They are big sources of capital and well worth approaching.
 
And it’s my understanding from colleagues, from the networks, from information in general, that there’s a considerable amount of U.S. money that’s been parked in Hong Kong. It’s sitting here, waiting to be invested, because this is an area that you can make something out of. You can put your money and you can see something rise, which is not so true in Europe and the U.S.
 
What about doing an initial public offering?
You don’t need to go to the market and dilute the stock, unless you have to. It’s the most expensive form of capital. If you got a good project, you’re actually better off doing it alone, or if you can’t pay for it, using somebody else’s money.
 
But I’ve always thought that an IPO is essentially free money.
It’s not really free money as you have to conform to a set of strict criteria and to raise that money, you have to behave in a correct fashion.
 
How about corporate bonds, for example?
That market seems to be taking off again recently. It had been very suppressed, but everything that I read in the press suggests that market is starting to really power up again.

 

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