Kepco completes first step of Asia's largest liability management exercise

The Korean electricity utility receives court approval for its consent solicitation covering $2.95 billion of its dollar debt.

The first stage of a comprehensive liability management exercise covering all of Kepco's domestic and international debt was completed this week, when the Korean courts approved a consent solicitation for eight Yankee bonds. This means Kepco can now introduce a streamlined covenants package across its outstanding Yankee bonds and remove clauses covering "joint and several liabilities."

For lead managers Credit Suisse First Boston and Lehman Brothers, completion also rank as a minor coup since the two were able to obtain investors consent without Kepco needing to pay a consent fee.

Launched in mid-November, the consent solicitation was prompted by the restructuring of the Korean electricity industry, which has seen six gencos split off from the parent, leaving Kepco as a transmission and distribution company. When the gencos were hived off in 2001, a series of cross guarantees were put in place to compensate the gencos for being assigned the same debt to capitalization ratio as the integrated entity prior to the split. This meant that all debt incurred prior to April 2001 had cross guarantees with the parent and with each other.

Since no outside investor would purchase a company with such huge contingent liabilities on its books, the cross guarantees needed to be unwound and in their place, the Korea Development Bank (KDB) stepped in to provide its own guarantee to all parent and genco debt that had previously had a cross guarantee.

At the same time, Kepco also needed to amend documentation on some of its foreign currency bonds, which had provisions requiring majority government ownership. Some covenants stated that should government ownership slip below 51%, investors had the right to accelerate pre-payment of interest and principal under event-of-default clauses.

Of the eight yankee bonds, Kepco received investor waivers for six of the bonds in December and a further two in January. To amend the covenants it required a simple majority to vote in favour and to remove the cross guarantees, it had to assemble a one thirds quorum of investors and get two thirds of this quorum to vote in favour.

For the shorter dated Yankees, observers say it scored an average acceptance rate of 80% and on the longer dated bonds about 55%. The two most problematic bonds are said to have been its 2026 bond puttable in 2006 and 2027 bond puttable in 2004, which required an adjournment meeting in January before the necessary acceptance rate was obtained. In these two cases, some investors argued that the value of the cross guarantees was greater than a KDB guarantee.

At the same time, Kepco also launched a consent solicitation for 11 eurobonds with principal value of $750 million equivalent. Where these bonds are concerned, Kepco needed to get a 50% quorum and 75% acceptance rate from the quorum for the covenants package. For the "joint and several liabilities" clauses it needed the same one thirds/two thirds quorum of the Yankee. Not all the bonds achieved this and required adjournment meetings in January. The Korean courts are currently deciding whether to pass these bonds since not all hit 50%.

The next step is the consent solicitation for Kepco's domestic bonds, which is being handled by KDB and Hyundai Securities. The bondholders meetings for these tranches of bonds will be held next week. Following this, Daiwa will hold a consent solicitation for about $450 million equivalent of Yen-denominated bonds.

As a result of the consent solicitation, the spread premium between Kepco and KDB bonds has narrowed in favour of the former. Where previously the two traded at a 15bp to 25bp differential to each other, it is now more like 10bp. When, for example, the consent solicitation was launched, Kepco's September 2007 bond was trading at 139bp over Treasuries and is now being quoted at 134bp bid. A November 2006 bond from KDB, on the other hand, was trading at 99bp bid and is now at 134bp.

Observers say the solicitation will further benefit Kepco by freeing up credit lines. Asian banks will now book outstanding Kepco bonds as a KDB credit, although fund managers will continue to treat outstanding Kepco bonds as just that.

Kepco is believed to have paid similar fees on the solicitation as it would on a standard bond issue, meaning that the two leads have netted about 25bp on $3.7 billion of debt.