South Korea’s largest construction equipment maker Doosan Infracore Co. wowed Asia’s capital markets with a rare US$500 million hybrid deal on September 25 that is designed to be counted as equity on their balance sheets. The deal is creating a buzz among lower-tier Korean companies that such a deal can also help them improve their balance sheets and pave way for a new source of funding amid the economic downturn.
Doosan, which is not rated by international credit agencies, is spurring more unrated companies such as Korean Air and Hanjin Shipping into talks with underwriters to execute similar deals, according to bankers. A distinctive feature that separates Doosan’s 30-year non call five bond from previous Asian hybrids is that it receives a credit enhancement from Korea Development Bank, Woori Bank and Hana Bank.
But although the country’s hybrid market may be in its infancy, bankers say the ability for a plethora of lower-rated credits to take advantage of such issues may be limited because local banks will not be able to continue to provide these guarantees, and the weak credit standings will not merit the investor interest witnessed in the Doosan deal.
“Doosan’s credit standing doesn’t matter at all. That’s why it was important to get the banks on board,” said a debt syndicate banker away from the deal. “The most important point is that this is essentially a bank credit. Investors have bought this because the banks are guaranteeing it. And Doosan gets a credit rating for it.”
The deal drew US$3.5 billion in orders from 130 accounts in a Reg S deal and priced at 265 basis points (bp) over similar-tenor Treasuries from initial guidance of 300bps. That gives investors a 125bp pick-up over the secondary market average spreads of the Korean banks providing the guarantees.
Doosan’s deal comes as South Korean banks’ household loan delinquency ratios rose above 1% for the first time in six years and corporate loan defaults increased to 2% for the first time since 2003. South Korean conglomerate Woongjin Group’s bankruptcy filing on September 26 will also raise banks’ loan loss provisions to KRW1.2 trillion (US$1.1 billion) to cover the conglomerate’s KRW2.1 trillion in approximate loans, according to the Financial Supervisory Service.
The squeeze on banks’ balance sheets, which are coming at a time when the country is trying to whip the lenders in shape in preparation for Basel III, will make it more difficult for these banks to lend to lower-rated companies.
“This is a great deal for investors. They get to buy what is almost a bank credit and get paid good yields. But the banks may be taking a bit too much risk for this. Doosan is a very low-rated company.”
The banks entered into a credit agreement to lend outstanding principal and any accumulated distribution payments to a special purpose company called Core Partners to allow it to meet put obligations. It is this commitment from Korea’s banks that have been reflected in Fitch’s expected ‘A-‘ rating, while Doosan’s standalone credit profile has not been considered, according to a September 14 press release from the credit ratings agency, as the banks’ credit agreement will still be in affect even if Doosan declares bankruptcy.
“You’ll probably have a limit after a few and will probably go without [a bank guarantee]. It’s because this is the first time. Banks have a limit too, of course,” said another senior debt banker with knowledge of the deal, adding that this is a reason why it is appropriate to bring more quality credits to the hybrid market.
“I personally think single-A companies like Posco and SK Telecom should try this, just like Hutchison issued two billion dollars to protect their credit rating and raise capital. Domestic companies probably have thought, ‘do I need to go that far? Have there been any other local companies who did that?’ But we’ll see more of this as a way to raise more capital, and there’s no risk of dilution,” said the banker.
“Hybrids are very suitable for Korean companies that are rated at least single-A. You get to count these issues as equity, they’re cheaper considering the costs, and the implementation of IFRS will open the doors for more issues.”
STX Pan Ocean and Lotte Construction have also been named as potential issuers of this rare corporate hybrid deal, said another Hong Kong-based rival banker, who added that manufacturers, industrials and shipping companies will be seriously considering such a deal structure.
South Korean companies’ first half earnings dropped 24% compared to the same period last year to KRW31.8 trillion won, while the average debt ratio fell 0.28 percentage point to 135% at the end of June, according to the Korea Exchange.
International investors will also be keen in purchasing South Korean company credits that have less risk amid global volatility. Moody’s, Standard & Poor’s and Fitch had all raised South Korea’s sovereign rating to ‘Aa3,’‘A+’ and ‘A+’ respectively, citing resilience to global financial shocks.
“Of course, companies with high credit ratings and strong balance sheets will probably not look into issuing these types of instruments,” according to a senior debt banker with knowledge of the deal. “But if companies that are on a weaker footing rush to start issuing this type of debt, I wonder how much investors will be interested in that. Because this has a perpetual characteristic to it, personally if I have money, would I invest in a lower-rated credit that might not have a maturity? In a market where strong fundamentals prevail over yield, raisin the spread over 300 basis points may not do the trick.”