The Korea Housing Finance Corp. (KHFC) is preparing to issue a benchmark-sized covered bond in the international market, making it the first covered bond out of Korea since July 2011. Yet the timing of the deal – around the Chinese New Year holiday – as well as the institution’s motive to issue before Seoul passes its anticipated covered bond law raises the eyebrows of more than a few market insiders.
“There are some very good questions surrounding this deal – like why issue now before Korea passes its law, and why conduct the roadshow during Chinese New Year when half of Asia is on holiday?” asked one debt banker away from the deal. “There are benefits to waiting for a more standardised market [after the legislature enacts the covered bond law].”
According to industry insiders close to the deal, KHFC will meet with global investors this week in preparation for a US dollar-denominated covered bond – the issuer’s first covered bond since July 2011, when it sold a US$500 million five-year deal.
Bankers close to the deal further confirm that the bond will be “benchmark-sized” with a comparable tenor to its previous five-year deal. But unlike KHFC’s previous two covered bonds, which were linked to residential mortgage loans of several banks, this upcoming deal would only be backed by the mortgage loans of a single commercial bank.
“This structure is not a typical example of the covered bonds that KHFC had previously issued; it’s more of a collaboration between KHFC and one commercial bank,” said one Seoul-based credit analyst with knowledge of the deal. “It’s possible that the bank that is using its assets to back the KHFC bond would face a pricing difference if they were to issue their own bond, and that’s why they’ve approached KHFC. And also this bank cannot issue a covered bond themselves so they’re using the KHFC as a vehicle – the question is why they decide to do it now instead of waiting for the impending law to pass.”
According to Moody’s, the deal’s initial cover pool comprises 7,144 loans of approximately KRW734 billion (US$670.5 million), backed solely by residential mortgage loans in Korea.
Market sources declined to elaborate which bank would supply the assets, and calls made to the KHFC were unanswered by press time.
Citi, Nomura and Standard Chartered are the bookrunners on the deal.
Through the fog, analysts find several reasons for the issue. First, because the Korean legislature is expected to enact a covered bond law by August - which will standardise the structures and issuance protocols for these bonds - the market will be open to issuance to all banks for the first time, and may see a surfeit of supply. Data from Westpac suggests the market could grow to KRW10 trillion.
KHFC’s decision to issue early means that its scarcity may help it to achieve more favourable pricing, and at a time when other regional covered bonds are trading well in the secondary market.
This environment helped the other recent covered bond issues out of Asia, including Commonwealth Bank of Australia’s US$2 billion bond due in January 2016, which priced 32 basis points (bp) over mid-swaps last month, according to Asiamoney PLUS’ sister publication Euroweek Asia. This deal tightened to 25bp over mid-swaps in the secondary market by February 7.
Secondly, Korean banks are now facing tougher regulatory constraints on their capital as regulators look to cap record levels of household debt. For a commercial bank looking for cash to meet capital requirements, selling now through a well-known covered bond issuer will achieve the same end-goal. And because of the low-risk profile of covered bonds, it’s also likely that KHFC’s bond will price more cheaply than a vanilla bank bond.
However, analysts also see disadvantages to the strategy. According to the Seoul-based credit analyst, after Korean legislators implement the long-awaited covered bond law, investors will be able to turn to a standardised set of rules for issuance. This will make them feel more comfortable with the covered bond structure.
“Right now KHFC is able to issue through a contractual basis rather than legislative, which takes a little more time and education to get more investors familiar with the structure. But with legislative covered bonds, you get one set of rules and then investors can acclimate more easily,” said the analyst. “The market has been waiting for so long for this rule to come about. I would think that most banks would just want to wait for it...Generally the banks are enjoying a quite liquid market right now. They don’t have an urgent need to issue covered bonds to meet their capital requirements.”
One debt banker away from the deal adds that investors could look less favourably at the structure, as it’s unlikely that KHFC would replicate this template in the future.
“It’s going to be interesting to see how the market perceives this bond – they might maybe treat this as a one-off because every other covered bond will probably come after the law is enacted. The assets covering this KHFC bond won’t necessarily be the same, so investors could be treating this differently,” said the banker. “What we see here is really the exception to the norm.”
Analysts further believe that it’s unlikely the KHFC will issue more bonds under this structure, and the next covered bonds to come out of Korea will occur after the legislature enacts its covered bond law.
“People are definitely becoming more interested in this type of product, which is clear globally,” concluded the debt banker. “But most people across the line you are more interested in a standardised product where everyone understands the law. It will be a very good place for Korean issuers, so I think a lot of banks are just going to wait it out.”