Seoul's latest default

Behind the sale of Daewoo Motor to General Motors lies a controversial government default on Daewoo debt held by investment trust companies.

Since the Asian crisis of 1997-98, foreign media and research analysts have spilt a great deal of ink on the subject of whether South Korea has shed its bad habits and how genuine its utterances of reform.

Unfortunately, some now believe the government deserves a new check mark beneath the "just lip service" column. However, since few foreign players are directly involved and since the government entity in question is not internationally rated, this particular fracas has so far occurred behind the scenes of what appears on the surface a dramatic boost for the "genuinely changing" column: the sale of Daewoo Motor to General Motors.

GM has finalized a deal to take over most of Daewoo Motor's assets for about $400 million, less than 10% of the $7 billion rival Ford Motor bid for the company in 2000. The agreement is welcome evidence that Korea's bureaucrats and big business interests have a realistic picture of the true value of Daewoo Group's remains. Before the crisis, Daewoo Group was Korea's second-largest conglomerate.

Here's the rub: when Daewoo Group collapsed in 1999 with some W89 trillion ($69 billion) in liabilities, the government arm-twisted domestic investment trust companies to hold onto their Daewoo bonds, and in turn guaranteed them in full via the Seoul Guarantee Investment Corporation (SGI). SGI itself has a troubled history: it was fully taken over by the government later that year after making similar payment guarantees to financially troubled companies, including Hyundai Engineering & Construction and Hynix Semiconductor. It is now technically insolvent.

The Daewoo debt began to mature four months ago, but the government faced a problem: the proceeds from selling Daewoo Motor were far below what had expected back in 1999, in the days of multi-billion dollar offers from Ford. So SGI does not have enough funds to meet its obligations to local money managers, including foreigners with either a full local licence or asset management joint ventures.

SGI owes investment trust companies a total of W8.85 trillion ($6.9 billion), of which it has said it will pay W4.82 trillion from funds it receives from the Korea Deposit Insurance Corporation. Fund managers in Seoul say another approximate W3 trillion may be forthcoming from taxpayers. But this does not cover the full amount SGI owes the money managers, nor does it cover costs of rolling over the debt and overdue interest. The upshot: the fund management companies are expected by MoFE to cover about W700 billion ($545 million), with burdens divided amongst them based on assets under management.

Stiffened by foreigners, the Korea Investment Trust Company Association (Kitca) initially told MoFE this arrangement was unacceptable, and in July actually filed a lawsuit against the government. Fund managers then say that at a meeting between Kitca's chairman and the Financial Supervisory Service on September 3, the government asked Kitca to back off in return for the coming up with alternative proposals. But on the 10th, however, MoFE said no alternative would be forthcoming.

"Essentially the government is reneging on its word," says one angry fund manager.

There is another twist. Fund managers say local courts have ruled against Kitca, saying the investment trust companies violated FSS guidelines by overexposing themselves to Daewoo debt. But critics say the courts ignored the fact that money managers were forced to buy Daewoo paper by the FSS.

In the meantime, Kitca has lost its nerve and the lawsuit has been withdrawn. "We're back to the traditional pain-sharing methods of the government," says one Seoul-based fund manger. "Eventually the investment trust companies will 'volunteer' not to receive SGI payments. SGI is bankrupt many times over, but ultimately politicians are responsible for injecting fresh cash into it, and they have decided that fund managers must share the burden."

The first repayments from SGI on Daewoo paper were due four months ago but no money has been forthcoming. Instead, the government has opened negotiations with the industry about taking haircuts. "In my mind this is a default, no question about it," says one manager.

He adds that the government has been using investment trust companies to support the markets, but this row has damaged fund managers' faith. "Last year the government guaranteed W10 trillion of collateralized bond obligations to support the bond market and the majority were guaranteed by SGI. Why should we believe the government in the future?"

There has been no furore, partly because domestic investors only see this as a Daewoo-specific issue that has nothing to do with them, and because SGI is not rated internationally.

But international rating agencies are worried about the implications of the apparent default by SGI. Standard & Poor's, for example, has not ruled it a default, but officials there say the situation may in fact be a default or a selective default (when only some obligations are not met). Tokyo-based director of financial services ratings Takamasa Yamaoka says the SGI affair should not impact Korean banks' ratings, mainly because the problem has already been factored in.

It could be another matter for Korean sovereign ratings, says Takashira Ogawa, S&P's sovereign analyst in Singapore. He says the change in ownership of SGI makes this less than a clear-cut case. "We need to think this through carefully," he concludes.