Korea Housing Finance Corporation (KHFC) is taking the lead in helping the country expedite the development of its covered bond market by planning to increase bond volumes and tighten spreads in an attempt to attract more foreign investors.
The state-run agency is aiming for covered bond issuance sizes of US$1 billion in the future, and will seek to price covered bonds at a spread over Treasuries of around 50 basis points (bp) within five years, according to KHFC chief executive officer Seo Jongdae.
“If we continue to improve transparency and flexibility, I think eventually we should be able to price at 50bp [over underlying Treasuries],” Seo told Asiamoney PLUS. “It depends on how often we are able to issue, but I think we should reach that goal within five years.”
KHFC priced a US$500 million 5.5-year deal on February 26 at a 1.625% coupon that translated to 100bp over underlying Treasuries. The bond was priced at the tightest spread for a five-year bond for any Korean issuer after readjustments since the Lehman crisis in 2008, beating out other state-run agencies. Investors are entitled to recourse on underlying assets of the issuer in case of a default.
Seo said he is also planning to increase the number of deals to three per year to boost liquidity in a market that is not actively traded. It has issued one deal per year since 2010 worth a total US$1 billion.
The agency is the only Korean financial institution that is authorised to issue covered bonds in the international markets, but that will change after parliament ratifies legislation this year that will also allow commercial banks to issue covered bonds.
Despite criticism from rival banks that KHFC issued a covered bond before South Korea passed the covered bond law, Seo said the deal should provide a solid comparison when commercial banks begin issuing covered bonds.
“The deal should be a big help for other commercial banks when they issue covered bonds in the future because they can print based on this deal’s performance,” said Seo. “It will also help lower South Koreans’ interest payments on mortgages and attract more long-term funding because it’s difficult to access these tenors just from the domestic bond market.”
Only 10% of South Korean mortgage loans are issued with fixed rates, and the Financial Services Commission has required all commercial banks to raise that to 30% by 2016. The government is hoping that more covered bonds will help finance banks to provide fixed-rate loans and extend maturities to alleviate mortgage payments for South Koreans.
Such repayment abilities have deteriorated in South Korea in recent years after falling real estate prices and stagnant economic growth has increased debt defaults.
But the country’s covered bond market faces obstacles. Bankers said the government has asked Korean issuers to refrain from issuing foreign currency-denominated debt to swap into Korean won to prevent the currency from appreciating, resulting in the lowest year-to-date issuance since 2008. President Park Geun-hye also said she is determined to keep the Korean won stable. The won appreciated 9% in 2012, making it the largest gainer among Asian peers against the dollar.
“There are a lot of restrictions when issuing foreign currency debt to fund won needs because the won has appreciated quickly, and those needs had to be adjusted because it monetary supply is strongly controlled by the government,” said Seo. “So this time we had to get some permission to get to the market.”
Even after the covered bond passes, commercial banks may not be fighting each other to become the first one to issue because they are already able to borrow funding at cheaper costs already, according to a funding official at one of Korea’s top three banks.
“We don’t have plans to do issue covered bonds, it’s more like we’re just watching how things go,” said the official. “Covered bonds will require assets, but we can already fund at competitive rates already. Because covered bonds will give us long-term funding, we need to figure out where we can keep getting a steady flow of long-term assets to match that too.”
Still, Seo said commercial banks will have to abide by government plans to issue covered bonds, and that Woori Bank may be the first to do it.
“One way or the other the commercial bank will follow government policy. Commercial banks cannot ignore that policy,” said Seo. “Kookmin or Woori bank may come. Maybe Woori will be the first because Woori is still under the government control.”
Considering the fact that US$16-17 trillion in debt can be packaged into covered bonds, Seo said the banks must come onboard to help develop Korea’s market because the KHFC will not be able to do it on its own.
“We can’t issue that much because there is a guarantee limit based on our capital and if we take all of that we have to be solely responsible for default on the collateral. Our guarantee is also restricted to 35 times total assets,” said Seo. “We are almost at this limit for this year. Commercial banks should, and I persuade them to do it.”
To alleviate pressure on commercial banks, Seo suggested that the KHFC take on mortgage loans of low-income earners, and that the commercial banks take middle-class mortgage loans.
Overall, Seo said he is optimistic that Korean covered bonds will be able to compete against more developed markets such as Japan and Australia, which are able to issue in sizes of at least US$1 billion.
“Demand for these bonds comes from stability and returns. Japan’s covered bonds are stable but the coupons are low, and that is the case for Australia as well. The strong point of Korean covered bonds is that stability is rising and it also yields more. They issue around the 1% range but our bonds are still printed at 3% coupons. Korean bonds are competitive.”