Downgrades Worry Mirae as Yield Premiums Narrow: Korea Markets

Jul 02, 2014 9:46 pm ET

(For more markets columns, TOP CM.)

July 3 (Bloomberg) -- The disconnect between the drop in South Korean corporate borrowing costs to a 2007 low and the rise in debt rating downgrades is worrying investors.

The yield premium over the sovereign for three-year won- denominated bonds rated AA- fell to 32 basis points on July 1 from 51 basis points at the end of last year, according to data compiled by Bloomberg. Korea Investors Service cut ratings on 22 companies in the first half and upgraded 12, the worst ratio since 1998. Analysts have lowered 2014 profit forecasts 15 percent this year, the most in Asia.

Bond prices are rallying on a lack of supply, as companies sold 880 billion won ($870 million) less in notes than the amount that matured during the first half, Korea Financial Investment Association data show. The Basel-based Bank for International Settlements warned late last month that the search for yield may have made investors complacent about risk.

“I’m concerned credit spreads have tightened regardless of credit fundamentals and in spite of earnings that aren’t good,” said Shin Jae Hoon, head of the fixed-income management team at Mirae Asset Global Investments Co., which manages 54 trillion won. “The slow economy and some rate-cut expectations are pushing sovereign yields lower, while low volatility is increasing investors’ risk appetite.”

KT Corp., whose local AAA rating outlook was changed last month to negative from stable by Korea Investors Service, the local affiliate of Moody’s Investors Service, almost halved its spread to 16.8 basis points when it sold 170 billion won of five-year notes last week from 31 in earlier issues in September.

Lotte Issues

Lotte Shopping Co., the nation’s largest department-store operator, raised 400 billion won this week selling three- and five-year notes priced to yield 2.789 percent and 3.079 percent respectively, the lowest yet for its similar-maturity won paper.

Korean companies sold 29.7 trillion won of bonds in the domestic market in the first half, less than the 30.6 trillion won they repaid. Net issuance was a positive 11.65 trillion won a year earlier.

“With supply so tight and the government paying so little, people are desperate for yield and they’re willing to take a bit more risk in order to get it,” Chung Yeon Hong, credit analyst at Daewoo Securities Co., a brokerage of KDB Financial Group Inc., said on July 1. “More companies may face credit rating downgrades but this will not really affect investors’ sentiment as long as supply shortage remains.”

Downgrades, Dongbu

Seoul-based Korea Investors Service downgraded 38 companies and upgraded 26 in 2013, while it cut 22 companies and upgraded 22 in 2012.

Creditors of Dongbu Steel Co., which data compiled by Bloomberg show has about 110 billion won in bonds maturing this year, agreed on a voluntary debt restructuring this week. Posco, the country’s largest steelmaker that had its own local rating cut to AA+ from AAA last month by Korea Ratings Corp, dropped a bid to buy Dongbu Group assets.

“We’ll need to monitor whether credit events like Dongbu’s case sour the mood,” said Mirae’s Shin, who doesn’t see room for spreads to tighten further.

Analysts have cut 2014 profit forecasts for companies in the benchmark Kospi index by 15 percent this year compared with a 12 percent decrease in Vietnam. Lee Sang Hoon, chief financial officer of Samsung Electronics Co., said last month that the world’s largest smartphone maker expects its second-quarter earnings to be “not that good.”

Slower Growth

South Korea’s economy is forecast to grow by 3.6 percent this year, after expanding 3 percent in 2013, and 3.8 percent the following 12 months, according to estimates compiled by Bloomberg. That’s below the average of 4.4 percent since 2000. Gross domestic product in the second quarter will increase by 0.8 percent, according to a survey of 31 economists, lower than the 0.9 percent they forecast a month earlier.

Ten-year won-denominated government bond yields fell 34 basis points to 3.179 percent in last quarter, the biggest drop since the first three months of 2013, according to data compiled by Bloomberg.

“Interest rates have been kept low for quite a long time but most companies don’t seem to selling debt to boost investments,” Chun Byoung Jo, executive vice president at KB Investment & Securities Co., the top arranger of local corporate debt this year.

There’s less clarity now over whether the economy will follow the path projected by the central bank in April, Bank of Korea Governor Lee Ju Yeol told reporters in Seoul last month.

Weak Investment

South Korea’s industrial output declined 2.1 percent from year earlier, while manufacturers’ business confidence fell to a seven-month low for July. Recent signs of economic recovery aren’t strong because investment in facilities and construction remain weak, Finance Minister Hyun Oh Seok said in a July 2 meeting in Seoul.

Exports rose 2.5 percent in June, versus the 5.1 percent median estimate of economists surveyed by Bloomberg, as the won strengthened 5.2 percent last quarter, the biggest advance among 31 major currencies tracked by Bloomberg. The currency closed at 1,009.15 to the dollar yesterday, the strongest since July 2008.

“Since economic growth momentum is still uncertain and domestic consumption is still weak, it’s difficult for companies to find investment opportunities and this makes bond sales slow,” said KB Investment’s Chun.

--With assistance from Nick Gentle in Hong Kong.