Bond Market Survives 'April Crisis' Rumors but Remains Unstable... When Will SPV Be Established?

Bond Market Finds Stability but Risks Remain
Expectations for Purchasing Low Credit Rating Corporate Bonds and CP through SPV Establishment

[Image source=Yonhap News]

[Asia Economy Reporter Kim Eunbyeol] Although the financial market turmoil caused by the novel coronavirus infection (COVID-19) and the so-called 'April crisis theory' have been safely overcome, experts unanimously agree that it is not yet time to relax. While the corporate bond market has found some breathing room, the elevated interest rate levels have not calmed down, and there are still factors that could exacerbate the crisis, such as credit and liquidity risks.

According to the financial investment industry on the 3rd, the credit default swap (CDS) premium for foreign exchange stabilization bonds (Oe-pyeong-chae) (5-year basis) averaged 0.36 percentage points last week, down 0.15 percentage points from mid-March (0.51 percentage points). The Oe-pyeong-chae CDS premium is considered a representative indicator of external soundness.

The corporate bond market has also overcome the crisis. Initially, there were concerns in the market that liquidity supply would be disrupted in the corporate bond market in April. This was because about 6.5 trillion won out of the total maturity volume of 50.9 trillion won this year was concentrated in April. Typically, April is considered a month with a large volume of maturing corporate bonds and high issuance activity. However, in the April corporate bond issuance market, there were no cases of purchase orders falling short of the demand forecast target amount except for Hanwha Solutions (AA-).

The short-term funding market, including commercial paper (CP), which showed unstable trends due to quarter-end funding demand and securities firms' margin calls (additional collateral demands) in March, is also stabilizing.

The problem is that the already elevated corporate bond interest rate upward trend has not been curbed. According to the Korea Financial Investment Association, the interest rate on 3-year maturity 'AA-' rated unsecured corporate bonds recorded 2.218% per annum as of the market close on the 29th of last month. Except for the previous day's 2.224%, this is the highest level in over a year since April 24 last year (2.219%).

Even after the Bank of Korea held an emergency Monetary Policy Committee meeting on March 16 and lowered the base interest rate from 1.25% to 0.75%, a 0.50 percentage point cut, corporate bond interest rates have not fallen but rather risen.

Therefore, companies still face a high burden when raising funds through corporate bonds. Experts are particularly concerned because the COVID-19 situation is expected to prolong, and the impact on export companies and others is expected to intensify from the second quarter. Since lockdown measures began in major countries such as the United States and Europe from March, the economic slowdown in the second quarter is expected to be greater than in the first quarter.

If companies that have not secured sufficient liquidity fail to properly raise funds, it could lead to corporate bankruptcies and amplify credit risk issues. The government's rapid increase in national bond issuance to fill the economic gap through fiscal spending is also a factor that raises funding costs for companies that need to issue corporate bonds.

Therefore, the government plans to establish a special purpose vehicle (SPV) to purchase low-credit-rated corporate bonds and is currently discussing this with the Bank of Korea, the Korea Development Bank, and others. The scale of low-credit-rated corporate bonds to be purchased through the SPV is expected to be about 20 trillion won.

However, the detailed structure and purchase scope of the SPV have not yet been finalized. The Bank of Korea is leaning toward an indirect method based on the principle of minimizing losses, where it lends to the Korea Development Bank, which then lends to the SPV. The scale will be determined depending on how much guarantee the government provides to the SPV, and the amount of corporate bonds and CP that can be purchased is also expected to be finalized.

Previously, the bond market stabilization fund, established with funds contributed by financial companies, is currently purchasing bonds rated AA- or higher to minimize the possibility of financial losses.