The 10 non call five transaction marks the first dollar-denominated subordinated debt issue from Korea since June 2000 and the first upper tier 2 issue to be targeted predominantly at local accounts. It also represents a step forward in the evolution of the kimchi structure designed by Salomon Smith Barney and first put to use earlier this summer on a $110 million issue for Hyundai Motor.
News of KorAm's impending issue, which is likely begin roadshows at the beginning of November, has already had a marked effect on existing subordinated debt spreads from the Republic and appears to have prompted a re-pricing of the entire curve. This is largely because the bank is hoping to secure a yield around the 7% mark equating to about 350bp over Treasuries. At these levels, it will price around 300bp inside the current trading levels of both Hanvit and Cho Hung Banks' upper tier 2 deals and 400bp inside Korea Exchange Bank.
All three deals were aggressively bid yesterday (Thursday), with Hanvit Bank's 12.75% 2010 upper tier 2 issue trading up to 107/108, a bid/offer spread of 643bp/609bp over Treasuries and yield of 9.96%. Only a day earlier it had been bid at 688bp over.
KorAm hopes to meet its funding targets by arbitraging different credit perceptions between local and international investors. The structure of the deal also melds international and local standards, underscoring the bankÆs motto, "Global best practice, local execution."
Observers say that there will be an international roadshow, as well as an overseas listing and Eurobond documentation. In this respect, the deal differs from Hyundai MotorÆs issue in July, which was a locally registered and documented US dollar-denominated transaction.
"The idea is to create a proper, liquid security, which will be predominantly placed domestically, but retains the option of being placed and traded overseas," explains one observer.
KorAm is said to be keen to embark on global roadshows because it wants to engage international fixed income investors. Indeed, the bank also embarked on a non-deal roadshow for equity investors yesterday (Thursday), with Deutsche Bank at the helm.
However, most international investors are likely to baulk at the idea of purchasing a deal, which will be completely out of kilter with the rest of the Korean dollar-denominated sub debt curve. Domestic investors on the other hand, are being offered a roughly 100bp pick-up between the domestic and international markets even after the basis swap has been taken into consideration.
Earlier this year, for example, KorAm raised W100 billion in lower tier 2 debt from a five-a-half-year deal currently yielding 6.8%. In the international markets, there is only a marginal 20bp differential between upper and lower tier 2 debt and observers say that domestic investors are unlikely to make much differentiation in credit quality either.
"It is virtually impossible to do upper tier 2 debt in the Won market," one observer explains. "It is technically possible to do it on a private placement basis, but the rules are so restrictive it would never be practical. But a lot of dollar-denominated paper has migrated back to Korea in the secondary market and this deal should ride that tide."
"Korean investors have come a long way in their understanding of sub debt," a second explains. "And as a result, pricing is improving all the time. The first domestic issues priced their deals around the 8% mark. Yields then tightening down to the 7.5% level at the beginning of this year and now weÆre at 6.8% to 7%."
Why though would domestic investors purchase KorAm debt so far inside the levels of other comps? And if this is the case, why have other bankers not targeted them before? Observers say that the former can easily be explained by the fact that domestic investors do not view Hanvit, Cho Hung and KEB as comps, even though they all share a Ba2 sub debt rating one notch higher than KorAmÆs Ba3 rating.
Where the latter is concerned, the Ministry of Finance & the Economy formerly forbade domestic institutions from purchasing the subordinated debt of government re-capitalised banks in the primary market, although it has allowed paper to drift back to Korea in the secondary market.
One banker comments, "Domestic investors make a strong differentiation between tier 1 and tier 2 banks. Although foreigners and particularly the rating agencies love Hanvit, Cho Hung and KEB because of their government ownership, local investors view them as lesser entities. In Korea, investors much prefer tier 1 banks such as HC&B, Kookmin, Shinhan, Hana and KorAm."
All observers agree that KorAm deserves an upgrade from the agencies, although it already commands a higher bank financial strength rating of D- compared to E+ for Cho Hung, Hanvit and KEB. Bank officials believe that an upgrade will be forthcoming.
Says one, "Over this last year we have doubled our paid-in capital and are now 60% foreign-owned. Our profits have increased substantially and our NPLs decreased markedly. ItÆs about time."
The official adds that the bank has opted for upper tier 2 debt because it is almost full on lower tier 2 debt. KorAm currently has a capital adequacy ratio of 10.6% of which tier 1 capital comprises 6.3% and tier 2, 4.3%. Although the ratio is within the governmentÆs 10% minimum, the bank wants to bring it up to 11% because it intends to increase its W30 trillion asset base during 2002, which will bring it back down.
"We have no immediate need for capital," the official says. "This is a case of forward planning and taking advantage of US dollar interest rates while theyÆre at low levels."
Following the sale of a 40.1% stake to a Carlyle and JPMorgan led consortium at the end of last year, KorAm has moved aggressively to clean up its balance sheet. Previously, the bank had been badly hit by the collapse of its founding shareholder the Daewoo group to which it had W1.2 trillion in loans outstanding.
At the end of 2000, it registered a net loss of W396 billion due to loan loss provisions of W979.7 billion which also depressed its CAR to 8.65%. Over the course of 2001, however, the bank has reduced its NPLÆs to a current level of 6.74% and is planning to end the year at 2%. It has also forecast a net profit of W200 billion.
"We have been very aggressive about our provisioning," the official continues. ôWe have set aside 80% in provisions for loans which are sub-standard or below. Where Hynix is concerned, most of the Korean banking sector has only provisioned around the 20% level. At the end of September, we had provisioned for 50% and at the end of the year, intend to increase provisions to 80%.
KorAm officials hope to have the sub debt deal wrapped up by mid-November. Salomon, meanwhile, is also working on kimchi issues for Samsung America (a $100 million three year FRN) and Hyosung Hong Kong (a $30 million deal).
Because of its domestic distribution network in Korea, the US investment bank has a huge advantage over its rivals and in this case, JPMorgan, whose shareholding in KorAm should have made it the obvious lead manager of a bank capital deal.
Bankers conclude that any Korean-related borrowers with US-dollar funding needs, can create a substantial pricing advantage for themselves by placing paper domestically. Since most accounts want to swap back to won, growing liquidity in the swap market is facilitating ease of execution. Excess liquidity in the bank market is also underpinning an investor base that has been the bedrock for virtually every successful dollar denominated deal from Korea this year.
"ItÆs cheap dollar funding," one banker concludes. "Local investors are almost always more comfortable with the credit than international investors and theyÆre a great lever to bring pricing in."
