knocs-1-billion-bond-sends-korean-credits-rallying

KNOC's $1 billion bond sends Korean credits rallying

The five-year issue by the state-owned oil company comes at the tightest spread for a quasi-sovereign so far this year, and leads to a narrowing of the Korean credit curve.

Korea National Oil Corporation (KNOC) early Friday (Hong Kong time) became the latest, and perhaps the last, Korean borrower to tap the international bond markets before the usual summer lull. The wholly government-owned oil company raised $1 billion with a Rule 144a/Reg-S five-year transaction, and achieved the tightest pricing for a Korean quasi-sovereign issuer so far this year after attracting orders worth at least $7 billion.

The deal was launched at the end of a week of aggressive marketing, and gathered such momentum that other recent Korean bond issues also rallied strongly, attracting European as well as Asian demand.

This was the first ever offshore public offering by KNOC, and the proceeds will be used for general corporate purposes, including working capital, capital expenditure and repayment of outstanding debt. The offering document contains a change-of-control covenant, allowing holders to sell their bonds back to KNOC at par should the Republic of Korea no longer own, either directly or indirectly, at least 51% of the company.

The senior, unsecured bonds pay a semi-annual coupon of 5.375%, and were re-offered at 99.344 to yield 5.527% to a maturity date of July 30, 2014. That translated into a spread of just 300bp over the yield on the benchmark five-year US Treasury note.

Initial price guidance of 325bp over Treasuries was announced on July 22 at noon, but the order book built up rapidly, according to sources familiar with deal. By the following morning in Asia, the bookrunners had received orders worth $6.2 billion and were able to tighten guidance to a range of US Treasuries plus 300bp-312.5bp.

A continued order flow meant the terms could be fixed at the narrow end of the range when New York opened, and KNOC was also able to increase the size of the transaction to $1 billion, having earlier been in the market for $500 million. 

The lead managers, Bank of America Merrill Lynch, Barclays Capital, BNP Paribas, Deutsche Bank, J.P. Morgan and Korea Development Bank, organised a two-team investor roadshow at the beginning of last week, with one team marketing in Hong Kong, Singapore and London, and the other visiting Los Angeles, New York and Boston. Nevertheless, and despite an apparent under-allocation to Korean investors, 45% of the deal was placed in Asia, while 28% and 27% was sold into the US and Europe respectively.

Bonds were allocated to a large number of accounts -- 360 in total. Among them, asset and fund managers were the biggest buyers with about 45%. Commercial banks took 24%, insurance companies 18%, central banks 7% and the remaining 5% (allowing for rounding) was placed with miscellaneous investors.

The Korean quasi-sovereign five-year cash sector surged and spreads tightened by as much as 60bp during last week. The attraction to non-Asian funds were the high spreads offered by Korean single-A credits relative to recent European borrowers with similar ratings. At the same time, there was still juice for onshore Korean accounts which could take advantage of the cross-currency swap and lock in a yield premium over won-denominated government bonds.

However, by the time KNOC was launched, the terms of both the cross-currency swap and the basis swap were less compelling, according to analysts. Instead, the deal was driven by offshore investors across different regions who saw this as a final opportunity to buy a leading Korean credit -- even though state-owned Korea Railroad Corp might issue in the next few weeks. No doubt too, the KNOC lead manager banks would have provided a strong bid for similar credits in order to build and sustain momentum for their issue.

Before any price guidance was announced, comparable Korean state-owned entities were trading much wider than the final 300bp pricing for KNOC. For instance, Korea Electric Power Corporation's (Kepco) five-year deal was bid at 330bp, and Korea Gas Corporation (Kogas) and Korea Hydro Nuclear Power (KHNP), with the same tenors, were bid at 350bp and 357bp respectively. When guidance was revealed for KNOC, Kepco opened at 300bp and then tightened to 285bp, while Kogas and KHNP were both quoted at 320bp. After the revised KNOC pricing, these spreads narrowed even more, to 275bp, 300bp and 305bp respectively.

And the rally didn't stop there. On Friday, after the pricing, KNOC was bid at 271bp and offered at 268bp, while Kepco was quoted at 270bp-260bp, Kogas was at 285bp-275bp and KHNP was at 290bp-280bp. During this period, Korea's sovereign five-year US dollar benchmark bond tightened from 250bp to 223bp, further assisted by a healthy performance by broader Asian bond indices, such as the iTraxx, and strong regional equity markets.

It's also worth noting that the yield premium demanded for state-owned entities over the Korean sovereign has narrowed significantly in July. Investors needed just 60bp for KNOC, while the spread difference for Kepco on July 13 was 95bp and for Kogas on July 9 it was 138bp.

The KNOC issue is rated A2 by Moody's and the equivalent single-A by Standard and Poor's -- the same as the sovereign credit rating, and the fifth lowest investment grade rating.

In a note released July 16, senior Moody's analyst Renee Lam said that the "A2 rating primarily reflects KNOC's dominant market position, distinct policy role and high operational integration with the government, as well as the presence of regular government financial assistance".

"These strengths collectively enhance the company's credit profile and enable it to enjoy strong access to the debt markets. They also suggest that KNOC's rating is closely linked to that of the government," she added. But she warned that these strengths are partly offset by the company's "sizeable upcoming capital expenditure programme...which will increase the company's leverage".

Established in 1979, KNOC is a 100% government-owned upstream exploration and production company, with an average daily oil and gas production volume of 75,477 barrels in the first quarter of 2009. It was set up in 1979, and is part of Korea's Ministry of Knowledge and Economy.

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