Korea Exchange Bank (KEB) will be hoping to ride on the back of renewed bullish sentiment towards emerging market debt when it prices a $200 million upper tier-2 capital issue on Monday. Led by Credit Suisse First Boston, the 10-year non call for five transaction is in the final stages of pre-marketing following investor presentations across the US this week and conference calls with investors in Asia and Europe.
Having been first mandated in April, many market participants were beginning to doubt that the deal would ever see the light of day following a sharp spike in the secondary market spreads of outstanding benchmarks. In the space of three weeks during May, for example, subordinated debt issued by Hanvit and Cho Hung Bank slid from trading prices of 104 to 92.
At the height of secondary market volatility during the week beginning 22 May, yields on Hanvit's existing 12.75% 2010 upper tier-2 deal hit the 16% mark before recovering a few weeks later. This week has seen further significant contraction, with Hanvit and Cho Hung trading at respective bid/offer spreads of 675bp/665bp and 670bp/660bp.
In terms of market conditions, few would doubt that KEB is benefiting from fortuitous timing. Having sat on the sidelines for the last few months, emerging market investors in particular have been back in force over the last few weeks, seemingly comforted that the US Federal Reserve will not maintain an aggressive interest rate policy.
KEB exploits issuance window
KEB has been the only Asian issuer either willing or advanced enough with its documentation to be able to take advantage of the issuance window. The rally has also been beneficial to the bank since it needs to complete a deal by 30 June in order to meet 10% bank capital requirements under the Korean Financial Supervisory Commission's (FSC) 'Forward Looking Criteria'.
In terms of stand-alone credit issues, however, timing has been less ideal and coincided with problems at Hyundai Investment Trust Company, to which KEB is the largest creditor bank, and rumours that the government will merge three weak state-owned banks into one.
Observers consequently believe that the deal will need to be priced about 50bp wide of current secondary spreads and indicative price talk is pitched in a 30bp to 50bp range. As one banker put it: "The deal will need a 20bp to 25bp new issue premium and probably a further 20bp premium because it is not as well regarded as Hanvit and Cho Hung."
Although some market participants believe that the deal may be increased subject to demand and generous pricing, bankers say that this is unlikely. Bankers add that although demand has been strongest in the US, it has been more widespread than initially envisaged at the beginning of the roadshow process.
"Demand has been broader than expected and there is some new money coming in from accounts that haven't participated in the other subordinated deals this year," one banker comments.
A second notes: "The risk appetite is back. Some accounts have been sitting on up to 25% cash over the past few months and want to put it to work again now they believe the Fed won't do anything too drastic any time soon."
Others, however, believe that unless the deal is generously priced many investors will remain nervous about getting caught out in after-market volatility. As one banker states: "The investor base for these deals is very institutional because banks don't want to count it against their own capital. Many investors got quite a shock when prices plummeted in May, and are wary that the same thing may happen again if the markets start getting volatile again after the next FOMC meeting."
Confusion over mergers
Bank analysts also express caution about the confused status of Korea's latest round of bank mergers. Although the government initially indicated that Hanvit, Cho Hung and KEB would be merged into one super bank, it appears that KEB has now been dropped in favour of Seoulbank under pressure from shareholder Commerzbank.
Indeed, while Commerzbank's risk management expertise has been pushed as one of the bank's key credit strengths during roadshows, analysts believe that its stake may act as a drag on the bank's future prospects.
"It's quite possible that having merged three weak banks into one, the government will further strip out their non-performing loans into a new AMC [asset management company] and leave a strong government-owned bank," one analyst explains. "But where will this leave KEB? The government has indicated that it is a vulnerable bank and it may end up left on its own, the weakest of the pack."
Commerzbank holds a 31% stake compared with the government which owns a 32% split between the Bank of Korea and Export-Import Bank of Korea (Kexim). Some analysts question the future of Commerzbank's investment given that it is also in merger talks with Dresdner.
Should the government plough ahead with the merger, however, it is likely that there will be a positive rebound on Korean sub debt spreads which should provide investors with some encouragement.
In terms of ratings, Moody's rates Hanvit, Cho Hung and KEB all B1 for subordinated debt. Fitch and Standard & Poor's, in contrast, rate Hanvit and KEB B/B- and Cho Hung B+/B. Yet as one analyst points out: "S&P's ratings are a little odd if you look at where the bank's foreign currency debt ceiling are concerned. Cho Hung is rated BB, Hanvit BB- and KEB at the B+ level. Given its typical three-notch differential between senior and subordinated debt, this should imply that KEB be rated at CCC+ which would be clearly ludicrous as we're not talking Indonesia here."
While it seems clear that KEB is going to have to pay far higher spreads than either Hanvit and Cho Hung when they came to market earlier in the year, a number of bankers point out that the deal is still more palatable than other alternatives.
"You have to compare how expensive this is going to be compared to the cost of new equity not senior debt," says one specialist. "Actually KEB can't legally issue equity even if it wanted to because it's shares are currently trading under par value. To do so would be highly dilute to shareholders and amount to giving away returns of up to 400% if you listen to some analysts' forecasts for the share price over the next five years.
"KEB can leverage its lending against this capital," the specialist adds. "It regards it as a necessary bridge financing."
As of end December, KEB had a capital adequacy ratio of 9.76%. The new deal, should it remain at the $200 million mark, will add a further 0.6%.