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Hunt for yield overcomes credit disparity for Korean SSAs

13 Sep 2012

Despite missing an upgrade from Fitch due risks associated with their exposure to rising commodity prices, Korean agency issuers will continue attracting investors seeking higher yields.

Appetite for higher-yielding credits will continue driving Korean investors to sub-sovereign and agency (SSA) bonds regardless of a disparity in credit ratings between their debt and that of Korean sovereigns.

On Tuesday (September 11), Fitch Ratings issued a statement reaffirming Korean SSAs’ positive credit outlook but neglected to upgrade their ratings despite already raising the credit profile of the sovereign.

Fitch upgraded Korea sovereign credit one notch from ‘AA-’ to ‘A+’ on September 6. Its decision came weeks after Moody’s also elevated Korea’s sovereign rating by one notch, to ‘Aa3’.

However, Fitch did not raise the credit ratings of Korea’s state-owned entities. Of the 12 Korean SSAs, 11 of them (Korea Electric Power Corp., Korea Hydro & Nuclear Power, Korea East-West Power, Korea Midland Power, Korea South-East Power, Korea Southern Power, Korea Western Power, Korea Land and Housing Corporation, Korea Gas Corporation, and Korea National Oil Corporation) hold ‘A+’ ratings. The twelfth, Korea District Heating, has an ‘A’ rating.

Moody’s by contrast, upgraded six government-related financial institutions to ‘Aa3’ from ‘A1’.

According to Shelley Jang, associate director at Fitch in Seoul, the rating agency opted to keep the SSA ratings intact because of concerns the Korean government is not doing enough to financially support the agencies. And until Seoul shows that it will do more the SSAs’ credit profiles will be at a disadvantage to the sovereign.

“We’re not seeing enough tangible support from the government for these agencies while the credit profile of these companies are getting worse as the government continues to control pricing,” said Jang.

She explains that, because Korea does not have an abundance of natural resources onshore, the commodity-focused SSAs must import them from abroad. As the price of materials such as oil and liquefied natural gas (LNG) rise, these SSAs must pay more. Yet because the government caps the price of energy for Korean citizens, companies such as Korea Electric Power Corp. (Kepco) and Korea Gas Corporation (Kogas) must bear the brunt of these costs.

Jang explains that the government has not offered as much financial relief in the form of subsidies and equity swaps to these companies as it could, thus hampering their balance sheets.

“We want to see more actions from the government on this front,” she added. “At the moment we’re not upgrading automatically as we had done before. We’re going to take the time to access each of these companies according to their needs and profiles, not only because they have government backing.”

There may be an opportunity for this soon: state-backed corporates have already submitted their mid-to-long-term financial plans to the National Assembly, which is in the finalisation process. If the government recognises that the agencies are facing fiscal pressure, it is possible that regulators will increase consumer energy prices to help these companies cope, or offer them more subsidies or an equity swap agreement.

“These agencies have strong credit profiles, but we want to see what the government will do to see if any additional support is given to them,” said Jang. “The Korean government looks to be taking its approach to public-entity debt very seriously and it looks to promote transparency and accountability, so we’re going to keep an eye on these events and review ratings as needed.”

However, even if regulators do not meet expectations to better-support these SSAs, Korea bankers doubt there will be any repercussions on their bond yields in the secondary market, nor their ability to issue debt in the future.

“The ratings agencies may be correct in drawing a distinction between sovereign and state-owned enterprise (SOE) credits, but I don’t think this will lead to a greater spread between the two,” said one Asian rates strategist. “Korean investors don’t really care - people are inclined to buy these things anyway because they offer a higher yield than sovereigns and there’s enough confidence that the government will bail these agencies out if it comes to that.”

The three-year average spreads between three-year benchmark bonds of two SSAs - Kepco and the Korea Expressway Corproate - and three-year Korean Treasuries is 43 basis points (bps)-45bps.

While bankers agree that, in some scenarios, a lower credit rating would result in a state-backed company offering higher yields to overcome negative perceptions. But in Korea, where government bonds due in 2015 yield 3.25%, investors’ appetite for yield will overcome the disparity between ratings.

“Obviously it would be positive for these companies if they received upgrades from ratings agencies, but we haven’t seen any negative response that they didn’t receive one yet, at least for now, and we don’t actually expect to see a negative reaction,” said one Korea-based debt capital market (DCM) banker, explaining that Korean SSAs – which aim to regularly issue bonds for the remainder of 2012 – will be able to achieve the same prices as they have all year.

SSAs themselves also anticipate favourable market conditions despite what credit rating agencies say.

“The main reason that we haven’t received any upgrade signal from the rating agency compared to financial institutions like [Korea Development Bank] is because the government doesn’t have an explicit clause to back us up in quite the same way. But we have a lot of room to go upward still in spite of that,” said Hyoungill Kim, the head of Korea Hydro & Nuclear Power Company’s international finance team.

“Because the Korean won has been strong and the country has been stable, there’s a belief that the ultimate backer of these SOEs is that much stronger, and you can see that in investors’ minds the government will be able to back these SOEs for better or worse, even if they are incurring more debt,” concluded the rates strategist. “If at the end of their debt and losses start obviously imploding then we’ll start worrying about who is going to bail them out, but no one assumes this is going to happen. Investors are just in it for the yield.”

13 Sep 2012