Over the past year a succession of new or rare Korean credits have graced the international markets, underlining the hope that Korea will cement its role as a high profile source of high quality borrowers in the Asian debt markets. Observers believe that corporates can take advantage of this year's economic rebound to diversify their funding, using the international bond market to raise financing. But officials warn that the liquidity of domestic demand and a continued oversupply in many industries leaves little incentive for Korean issuers to look offshore. Richard Morrow reports on the market expectations for the Korean international bond market.
South Korea's national football team will compete before a worldwide audience of billions this summer at the World Cup, which the country is co-hosting with Japan. But capital markets professionals hoping for a similarly global showing from Korea's borrowers in 2002 may be disappointed.
Despite Korean international bonds performing extremely well over the past year, the country's borrowers were, on the whole, reluctant to launch international fixed rate deals. And Carsten Stoehr, head of Asia debt capital markets at Credit Suisse First Boston, believes that prospects for international Korean issuance are unlikely to improve over the next 12 months: "It remains very attractive for Korean issuers to borrow domestically because interest rates are low," he says.
Total international bond issuance (including asset backed deals) from Korea in 2001 stood at $6.03bn from just 35 deals, compared with $6.803bn from 52 deals in 2000. Korean issuance as a percentage of total Asian issuance in 2001 was 26.6%, down from 44.4% in 2000.
Stoehr at CSFB adds that as well as the factor of low local interest rates, the absence of currency risk and the liquid domestic investor base have acted to discourage overseas issuance. "This limited the number of offshore Korean borrowers in 2001 to those that either have international currency borrowing needs, or are specifically looking to diversify their funding sources or extend the maturity profile of their liabilities," he says.
A large proportion of the country's international deals were loan-style floating rate notes. Only a handful of benchmark fixed rate international deals were launched during 2001. "Many borrowers, such as Korean commercial banks, do not have the high credit ratings needed to borrow at fixed rates," says Joo Sang Rhee, manager for capital markets at Samsung Securities in Seoul. "So instead many of the borrowers issued FRNs."
However, one encouraging feature of fixed rate issuance last year was a revitalisation of the corporate pipeline. SK Corp initiated proceedings by launching a $250m five year issue in May. New borrowers such as Kumgang Korea Chemical (KCC) and Kia Motors followed, and LG Caltex also accessed the market in July.
CSFB had a joint lead role for SK Corp with Lehman Brothers, and was sole manager for the transactions from Kia Motors and LG Caltex. "The corporate issues last year were achievable because Korean spreads tightened dramatically, so international investors looked to get some yield through corporate Korean exposure," says Stoehr.
Newly created government finance holding company Woori also demonstrated its interest in using the capital markets last year. The issuer has launched four bonds since its debut deal in September. Three of these issues were domestic Korean won transactions, but in November Woori Financial Holding launched its first international bond issue, a $150m floating rate note bond maturing in 2004, which was sole lead managed by UBS Warburg. The FRN was priced at 160bp over six month Libor.
KDB makes benchmark
The largest international bond from Korea last year came from the Korea Development Bank (KDB) - a $500m five year global issue launched in November.
The KDB is one of the most frequent, bellwether Korean issuers and the best government proxy. The state policy bank embarked on a roadshow for its global bond in November to take advantage of the strong market sentiment and regional investor demand. Barclays Capital and Citigroup/SSB had the mandate to joint lead manage the five year transaction.
The deal itself was a blowout, closing almost 2.5 times oversubscribed. The issue was priced at 99.415 with a semi-annual coupon of 5.25%, to offer a spread of 182bp over. The strength of demand also ensured that the deal received wide distribution.
However, the pricing process of the deal had its detractors. Observers were concerned that while KDB officials wanted to price the new bond through the bank's own interpolated bond curve, at a level of 150bp-160bp over US Treasuries, banking officials close to the transaction were advising a level at about 185bp over.
Bankers believed that KDB officials were unhappy about the final pricing range, which was wider than an outstanding 2006 deal for the KDB. But observers familiar with the deal said at the time that the new issue could not be priced through the outstanding bond, which was artificially tight, as most borrowers at the time were paying premiums to get transactions away.
"Both the borrower and ourselves were happy with the transaction," says Stephen Roberts, head of Asia Pacific fixed income at Citigroup/SSB. "There were some questions at the time about whether the issue could have been priced tighter, but this is always a consideration and much of the negative comments was just sour grapes. The deal has since traded in line with the subsequent rally in the US Treasury market and it has of course tightened due to the Standard & Poor's [S&P] upgrade."
The fact that the KDB was upgraded to BBB+ along with Korea a few days later prompted some rivals to gloat at the deal's unfortunate timing. But the leads were happy enough. "We spoke to the rating agencies and made a compelling case about Korea and the KDB's situation," says Roberts. "Obviously we did not know that the upgrade would happen quite so quickly, but one could ask whether the upgrade would have happened so quickly if not for the issue. When one looks back in five years it will be obvious that the KDB borrowed at a time when it was very cost effective." The issue was trading at 138bp/135bp over in mid-January.
KDB officials also say that they are happy with the bond as a benchmark. "Together with the S&P upgrade days after the issue, the bonds have performed very well in the secondary markets," says Choi Pong Sik, head of the international funding team at the KDB. "It has provided a good benchmark for other Korean borrowers interested in the international market."
The last three months of the year also witnessed a number of corporate FRN Eurodollar deals, with LG Caltex following up its fixed rate deal to launch a $150m three year bond via ABN Amro and Citigroup/SSB, LG Electronics pricing a $100m five year FRN via KDB, and CSFB sole leading a $100m three year FRN for Samsung Hongkong.
Impressive spread performance
As in other emerging markets, Korean bond issues were affected by volatility after the events of September 11. But in general, Korean bond issues performed strongly last year as investor liquidity combined with the lack of primary supply to tighten spreads. S&P's upgrade of Korea's rating from BBB to BBB+ late in the year put the gloss on what had already been an excellent 12 months of secondary market performance.
The Korean component of the JP Morgan Asian Credit Index (JACI) returned 14%, with the sovereign returning 14.6% and the bank debt subcomponent returning 26.2%. This compares with a return of 12.9% for the overall JACI composite.
One reason for this was the strong domestic and regional support for Korean deals. "With domestic yields falling to historic lows, Korean investors in corporate bonds were looking for investment opportunities offshore with low risks," explains Young Chang, head of fixed income research at Samsung Securities. "There have also been efforts to diversify portfolios away from domestic exposure in anticipation of economic changes."
The benchmark Korea 2008 bond was the most obvious beneficiary, trading in from 239bp over US Treasuries a year ago to a bid/offer of 150bp/142bp over in mid-January. Bankers note that much of Korea's paper is trading tighter than US A grade corporate paper, but it still offers a good pick-up for domestic investors.
Many analysts believe that plain vanilla paper spreads are unlikely to continue to improve this year. However, at the same time, the strength of domestic and regional investor demand for Korean credits means that there is little chance of spreads widening in the coming months.
But where analysts believe tightening will take place is in the bank capital sector; specifically, the outstanding subordinated bond issues from Hanvit Bank, Chohung Bank and Korea Exchange Bank.
"Spreads on Korean bank sub debt seem positioned to tighten further," says David Fernandez, head of sovereign research at JP Morgan Singapore, in a recent report. "Post-provisioning profits are in the black again, and the positive outlook bodes well for loan growth. Further consolidation in the bank sector would be positive. Fundamentally we see Korean sub debt as undervalued."
Strong redemption schedule
With Korea's economy improving, interest rates at appealingly low levels and spreads at tight levels, the conditions for Korean borrowers to launch international deals are better than they have been for years.
A total of $20.6bn in international bond redemptions are due this year - a large refinancing need that bankers hope will be partially met through the international markets.
But despite the encouraging conditions, most observers are pessimistic about there being a marked surge in primary issuance. For many would-be borrowers, exposure to international debt is just not economic, especially when there is little evidence of corporates embarking on a spending spree.
"It looks as if there is going to be slightly less international issuance this year than was expected six months ago," says Citigroup/SSB's Roberts. "There is less capital expenditure and a liquid domestic market, and foreign direct investment is also increasing, which is relieving corporate financing needs. That is a good thing for Korea."
Marc Jones, head of Asia Pacific debt capital markets for JP Morgan in Hong Kong, agrees. "A lot of liquidity exists in the domestic market and there are few signs that big Korean borrowers are increasing their balance sheets," he says. "A few corporates could aim to access the market for some longer maturities, but generally we are more cautious about the strength of international Korean bond issuance this year."
According to KDP reports, industrial spending during 2000 reached W4.7tr, but in 2001 it was W4.1tr, and this year it is expected to be W3.9tr.
The KDB's Sik adds that the low interest rates have also played an important role in reducing the number of international deals. "Most of the commercial banks in Korea at the moment are looking to take advantage of the low domestic interest rates and liquidity of the market to raise finance, while many corporates are reluctant to take on the currency risk," he says.
Sik says that the state bank will look to arrange a benchmark deal again this year. "We plan to raise $2bn in international external financing, and a benchmark deal in either the third or the fourth quarter is likely," he says. "While our currency of preference is dollars, we have not discounted a euro issue, depending on market conditions."
He adds that the KDB has a dual role when considering international bond issues: "We do look to gain as competitive financing as possible, but we also have to act as a benchmark arranger for other Korean issuers."
Steady yen demand
The KDB is also a frequent borrower in the Japanese yen market, last year launching a benchmark ¥50bn five year deal in July via Nomura Securities. "A yen deal [this year] is possible, but we may resort to raising finance in dollars and swapping it into yen, depending on market conditions," says Sik. Other Korean names continue to pledge their support for raising funds in yen. Bankers expect that the pattern of Korean borrowers looking to borrow in Japanese yen is likely to be similar to that seen in 2001. "We would expect the regular issuers to access the market this year," says Tatsuro Higashi, head of capital markets at Nikko Salomon Smith Barney in Japan. "There is unlikely to be a massive increase in overall yen bond issues from Korea, but we could see ¥150bn-¥200bn overall."
But not everyone agrees. One banker argues that as a result of Korea's upgrade, a good deal of Korean paper now appears expensive for Japanese investors. He also points out that the spate of high profile bankruptcies in the US has dampened Japanese investor demand. "Investors are also averse to risk right now due to recent corporate problems from the US, so sentiment for all offshore yen deals is down," he says.
Along with the KDB, Korea Electric Power Corp (Kepco) is one of the most frequent Korean borrowers in the Japanese yen market. The partially privatised state utility has launched three Euroyen bond issues in the past two years.
Myung Wan Kim, general manager of the international finance department at Kepco, believes that yen will remain the most attractive of international currencies for the corporate. "We are expecting the Korean economy to improve and the Korean won to strengthen while the Japanese yen continues to weaken," he says. "This means that while we have not finalised our expenditure plans, it would be attractive to launch more yen issuance."
For Kepco, yen financing is also cheaper. "We can issue a five year bond issue in Japanese yen with a coupon level of about 1.5%, while a similar issue in dollars would be about 4.5%," Kim says. The company's preference for the currency is marked - since 1999 Kepco has raised $2.5bn equivalent internationally, $1.9bn of which is denominated in yen.
Pohang Iron & Steel Co (Posco) is looking to fund the majority of its W1.3tr refinancing needs domestically, but Youn-Gil Ro, team manager for the international finance team at Posco, says that yen is the one offshore currency that he could consider: "We import all of our goods but with dollars flowing into the domestic equity market and a mixture of strong exports to the US and weakening Japanese yen keeping exchange rates volatile, we are not interested in gaining exposure now."
Banks look at bonds
The outlook for bank sector transactions this year is promising. Maturing bank bonds already compose a large amount of the year's total redemptions. S&P has also recently upgraded Kookmin Bank to BBB- from BB+ and Korea Exchange Bank to BB- from B+, while altering its outlook on Shinhan Bank, Korea First Bank and Chohung Bank to positive.
"Banks could well look overseas to raise capital, especially following the recent S&P upgrades," says Citigroup/SSB's Roberts. "With local corporates looking to borrow domestically and banks extending liquidity, their capital requirements will increase too. This means we could see a variety of subordinated deals, together with securitised bonds such as receivable and property backed issues."
Kookmin Bank has plans to tap the international capital markets this year. Hyun Kie Cho, manager for the international finance department, says that Kookmin has $1.6bn of international financing needs this year and is looking at issuing an international bond in the second half. "We are going to speak with investors about raising a mixture of loans and FRNs in the first half," he says, "but with the improving economy and long term investor interest in the second half we will look to do a bond issue then." Cho says that a dollar vanilla bond with a tenor of three to five years is likely, as it fits with the bank's outstanding liability profile.
However, not all banks with redemptions coming up this year will use the international markets. The Export-Import Bank of Korea has several international bonds falling due in 2002, but no international issuance plans. Sung-Uk Hong, manager in the treasury department at Kexim, explains why. "We are looking to raise about $300m internationally, but believe that this is most efficient to raise through three year loans," he says. "Our clients only have foreign currency funding needs of about three years, and we only tend to borrow in the international bond market when we require tenors of over five years."
Bank names will belong to the small group of Korean borrowers that venture overseas in 2002. Most activity is likely to be within the domestic market, and in growth areas such as bank capital and structured finance. Overall, though, CSFB's Stoehr remains sanguine about the primary issuance pipeline from Korea. "There are three strong reasons that promote Korean bond issuance this year," he says. "Firstly, the asset backed securities market is continuing to build up steam. Secondly, there is a significant redemption schedule from Korean borrowers this year, and thirdly, there is a continuing broadening of the issuer base as investors look to borrowers that provide an attractive pick-up versus extremely tight sovereign and quasi-sovereign bonds."
Stoehr also believes that the redemption pipeline should result in a few notable new deals being launched in the coming months: "I would anticipate at least two or three bond issues with a size of $500m or larger this year.' *