State-owned Korea Electric Power Corp (Kepco) is the latest Korean borrower to tap the international capital markets, and it achieved such tight pricing for its $500 million five-year deal, which was completed late Monday Hong Kong time, that several analysts and bankers were left scratching their heads.
The issue was launched under Kepco's $1 billion Reg-S/144A-registered global medium-term note programme, which is rated A2 by Moody's and the equivalent single-A by Standard and Poor's. Both are equal to Korea's sovereign rating. The proceeds will be used for general corporate purposes.
But the Rule 144A status, essential for US participation, barely seemed necessary this time around, because Asian investors led the demand. In particular, Korean accounts provided a strong bid due to attractive terms in the cross-currency swap market. Five-year won-denominated Korean government bonds were trading at yields of around 4.5% and even after the swap, in a day when the Korean currency fell about 2.5% against the dollar, local investors could lock-in a healthy yield premium.
It was this factor, more than any other, that allowed the bookrunners, Goldman Sachs, HSBC, Morgan Stanley and RBS (and joint-lead manager Samsung Securities) to price the deal so aggressively.
The notes pay a semi-annual coupon of 5.55%, and were re-offered at 98.867 to yield 5.764% to a maturity date of July 21, 2014. The spread was fixed at 355bp over the yield of the benchmark five-year US Treasury note, which translated into a spread of mid-swaps plus 310bp. The price whisper at the end of last week indicated a range of 350bp-375bp over the Treasury yield, but that changed to the middle of the range -- 362.5bp -- during the afternoon of July 13 in Asia.
The total order book amounted to more than $3 billion and bonds were distributed to 136 accounts.
The final allocation reflected the Asian interest with 40% placed with accounts in the region and a further 20% sold to Korean onshore investors; 25% and 15% of the issue was bought by US and European accounts respectively.
Fund managers and investment advisers took 33%, insurance companies and pension funds stumped up for 31%, commercial banks bought 22% and the rest was placed with retail and private banks.
Korea's Financial Services Commission (FSC) said on July 5 that domestic institutional investors were, for the first time, allowed to buy a "limited amount of foreign currency-denominated bonds" issued offshore by Korean companies. "The new rule will lower interest rates companies have to pay in issuing foreign-denominated bonds abroad," said an FSC official, who added, "It will also increase the chance of successful overseas issuance of such bonds."
In the context of the highly successful placement of US dollar bonds by more than a dozen Korean issuers so far this year, the second rationale for the rule change looks irrelevant. However, the first seems to have had immediate results. How else is it possible to explain a spread of 355bp, when on a relative value basis the bonds looked so mispriced? And non-Korean investors must have been persuaded that there would be a strong secondary market, as Korean accounts with low primary market allocations might look to raise their holdings.
Two recent and obviously comparable deals are the five-year Korea Hydro Nuclear Power (wholly-owned by Kepco) which was trading at 385bp-380bp over Treasuries on Monday, and a hugely successful Korean Gas (Kogas) five-year issue, which was priced on Friday at 390bp. Kogas, which like Kepco is government-owned, was marketed on the basis that there would be no sudden increase in issue size, but had the additional feature that it was a "unique borrower". Yet, there are six other electricity generating companies in Korea, albeit held within Kepco.
But, Kepco is Korea's only fully integrated electricity utility and is the monopoly operator of the country's electricity distribution system. It generates over 93% of the electricity consumed in Korea through its six wholly owned generation companies.
"At the same time, Kepco is exposed to fuel cost and currency movements due to the lack of a transparent and formula-based tariff adjustment mechanism. This has seen the company's financial profile deteriorate over the past few years, in particular in the second half of 2008, given the high fuel costs and sharp depreciation of the won. This trend is expected to continue against the backdrop of expected weak electricity demand growth in the near term," said Moody's in a note released on July 13.
S&P wrote in a note on July 12 that its rating assignment is partly based on a belief that "Kepco will receive strong governmental support, based on the company's strategic importance to the domestic economy. But it added that "these strengths are offset by a lack of transparency in the electricity price-setting mechanism and a recent deterioration in [its] financial risk profile, which was caused to a large extent by the government's capping of the retail tariff".
Moody's ratings outlook is stable and reflects the agency's expectation that Kepco will maintain its dominant position in Korea's power sector, and that the regulatory environment will remain supportive. However, it warned that the possibility of near-term upward rating pressure is limited "given Kepco's deteriorating financial profile, a result of its exposure to fuel costs, the won exchange rate and the negative outlook for electricity demand growth".
