Korean Air Lines' attempts to improve its leverage ratios amid the collapse of its affiliate Hanjin Shipping came crashing down on Tuesday after the group pulled a $300 million hybrid bond issue following two days of attempted syndication.
The unrated group's 30- non-call three-year bond is believed to have fallen victim to a chasm that opened up between the borrower and its prospective investors' pricing expectations in an unforgiving market where the power has shifted (temporarily at least) from the former to the latter.
Korean issuers have never been known for their emollient attitude during pricing meetings as many bankers have recently been recalling in a series of interviews to mark FinanceAsia's 20th anniversary.
In this case, misplaced expectations are very likely to have been compounded by the huge uncertainty surrounding the fate of the national carrier’s 33.2%-owned affiliate Hanjin Shipping.
The world's seventh largest container vessel operator by capacity filed for Korea's version of Chapter 11 at the end of August after reporting continual losses since 2011 and amassing $5.4 billion in debt due to a prolonged industry downturn.
Nutty pricing?
As a result, investors were always going to be looking for a pricing premium to compensate for this big unknown and the fact Korean Air has no outstanding stand-alone bond issues to benchmark pricing against.
Non-syndicate bankers said they had received investor feedback suggesting price sensitivity around the high 7% level after preliminary market soundings late last week. However, sole lead Citi launched the bond on Monday with initial price guidance in the low 7% area.
On Tuesday, it went out with new guidance around the 7.5% mark, only for Citi to announce the deal had been pulled shortly after Asia's close, according to non-syndicate bankers. The US investment bank declined to comment.
Widening price guidance is often a sure fire way to create reverse momentum and scare away any remaining investors in an order book unless they feel pricing is just too cheap to miss.
Non-syndicate bankers said Citi tried to downsize the issue size to $100 million but could still not match demand with the borrower's rumoured pricing expectations around the high 6% area.
"The whole point of hiring investment banks is to get professional advice and in particular listen to what syndicate bankers say as they are closest to investors," one non-syndicate banker said.
The banker argued that the deal might just have scraped home around the 7.5% level had market conditions been fine, but the reality has been anything but over the past two days.
Monday's sell-off across Asian G3 investment grade bond spreads continued on Tuesday, particularly when Europe kicked in during Asia's afternoon and spreads ended the day wider again by about 3bp to 5bp, although some of Monday's new issues did trade up after being more generous with their own pricing.
As Korean Air is not rated it is hard to pinpoint where fair value for a bond should be. Had it priced a deal around the 7.5% level it would have certainly ranked as one of Asia's highest yielding corporate hybrids.
Agile Properties, for example, has a B+ rated 8.25% July 2049 (call 2017) deal outstanding. This was trading on a mid-yield around the 8.8% level on Tuesday.
Korean Air's debt levels also suggest a rating in the single-B category.
In sector terms, one clear comparable is Turkish Airlines, which has a Ba3/BB- rating. However, it is on negative outlook from both Moody's and Standard & Poor's and its rating is uplifted by sovereign support, which Korean Air does not benefit from with its chaebol backing from the Hanjin Group.
In June, Turkish Air reported total debt to Ebitda of 6.9 times, according to S&P Capital data, compared to Korean Air's level of 5.7 times.
The latter's elevated debt ratio was the driving force behind its hybrid deal, which would have counted as equity on its balance sheet. According to S&P Capital data, the group's total debt to equity ratio stood at 792% at the end of June.
In a recent research report, UBS pegged the ratio even higher at 836% and pointed out just how close this now stands to distressed levels last seen during the Asian Financial Crisis.
It also highlighted "further risks ahead" after Korean Air agreed to lend money to Hanjin Shipping so its container fleet can finally dock in port.
Cut adrift?
Once Hanjin filed for court receivership at the end of August, global ports stopped accepting its ships for fear of not getting paid, leaving an estimated 97 vessels and $14 billion of cargo adrift around the world.
The Korean government has since helped broker a deal, which led Korean Air to lend the group Won60 billion ($55 million), with lead creditor Korea Development Bank throwing a Won50 billion lifeline, Hanjin Group chairman Cho Yang-Ho floating Won40 billion and former chairwoman Choi Eun-Young Won10 billion.
However, analysts say the combined amount will not be enough to cover the docking fees for all the ships and believe the government is taking a hard line to make sure Korean Air funds any additional expenses.
Analysts also believe the collapse of Hanjin Shipping has come to represent a line in the sand for the government and its attitude to the country’s ailing shipping and shipbuilding industry, not to mention its attempts to lessen chaebol power.
Last year, it was heavily criticised for engineering a Won4.2 trillion bailout of Daewoo Shipbuilding and Marine Engineering (DSME) with the help of Kexim and KDB.
As numerous analysts have pointed out, Hanjin might be far easier to let go as it has less than 1,500 employees compared to 40,000 at Daewoo, which is also now under investigation for accounting fraud.
Arctic Securities, an investment bank specialising in the shipping sector, concludes that Hanjin Shipping is unlikely to get a state-directed bailout on the basis of the government's attitude so far.
In a recent research report, the Norway-based brokerage said: "A key difference in Hanjin's decision to file compared with container operator restructurings over the past year is the lack of support from both government bodies as well as Korean banks."
"Hanjin's downfall is said to have been too much for South Korean politicians in the wake of the troubles and unveiling of financial malpractice at South Korean shipyards," it added.
Arctic Securities say 30 domestic and international banks have exposure to Hanjin, and Korean Air has posted a net loss since 2013 after continually writing down its loans and investments in the group.
On the plus side, Korean Air’s debt to Ebitda may be high but it is moving in the right direction having stood at 9.3 times at the end of 2013. In March 2015, the group was also to expand its equity base after completing a $440 million follow-on offering.
Non-syndicate bankers acknowledged the group was extremely unlucky to launch a bond deal on the very day markets turned. “Markets can move quickly and last Thursday’s post Fed euphoria quickly dissipated,” said one.
“A more experienced borrower would have been able to react to this a lot better.”
For chairman Cho, the demise of a bond issue by Korean Airlines also probably represents but a small blip in a long line of negative public relations events concerning the chaebol founded by his father Cho Choong-Hoon. These range from his daughter’s nut-rage incident to being sued by his own pilots after describing flying on auto-pilot as easier than driving a car.
During the latter part of the 20th century, former president Kim Dae-Jung also lambasted the company for a management style and corporate culture that appeared to be causing numerous crashes.
