[Donmaekgyeonghwa] Growing Calls for Accountability of Government and Financial Authorities

[Asia Economy Reporters Song Hwajeong and Shim Nayoung] Concerns over credit tightening are growing due to the Legoland incident. Credit spreads have surged to their highest levels since the global financial crisis, and the bond market is drying up, with even high-grade corporate bonds facing unsold issues, spreading a crisis of 'financial stagnation.'

On the 20th, the Financial Services Commission announced measures such as deferring the normalization of the Liquidity Coverage Ratio (LCR) and activating the Bond Stabilization Fund to stabilize the market, but criticism has arisen that proactive responses should have been taken earlier as the market situation was already deteriorating.

The final default of asset-backed commercial paper (ABCP) related to the Gangwon-do Legoland development occurred on the 4th, but for two weeks, the government and financial authorities only talked about strengthening monitoring without taking any significant action. In the commercial paper market, ABCP interest rates rose from 3-4% a month ago to 7%, and at one point, refinancing was impossible, showing symptoms close to a seizure. In the corporate bond market, since the beginning of the year, banks issued a large volume of bank bonds due to the government's LCR normalization, and Korea Electric Power Corporation (KEPCO) issued 18 trillion won in KEPCO bonds this year due to continued deficits. The massive issuance of these high-grade bonds absorbed funds from the bond market, making it difficult for other corporate bonds to be issued.

On the 21st, the financial market criticized the government for escalating the crisis by not taking preemptive measures and called for the swift implementation of additional actions. Above all, there is unanimous agreement that the Bond Stabilization Fund should be expanded to purchase lower-rated corporate bonds and supply liquidity.

A representative from a commercial bank said, "On the 20th, the Financial Services Commission announced it would release 1.6 trillion won from the Bond Stabilization Fund to stabilize the bond market, but bond yields actually rose on the 21st. The market consensus is that this scale is far from sufficient," adding, "The Financial Services Commission should send a clear signal about how much more funds it can inject into the market by increasing the size of capital calls mainly operated by financial holding companies."

Another commercial bank official said, "The short-term funding market has been deteriorating for about a month, and if the authorities had been monitoring it, they could have taken market stabilization measures earlier, which would have prevented the amplification of market anxiety."

Companies Cry Out Over Fundraising

According to the investment banking (IB) industry, as the bond market freezes, even high-grade corporate bonds are failing to find investors. On the 17th, JB Financial Group conducted a demand forecast for a 100 billion won public bond issuance, planning to raise 80 billion won for the 2-year maturity and 20 billion won for the 3-year maturity, but the demand forecast results amounted to only 23 billion won for the 2-year and 15 billion won for the 3-year, totaling 38 billion won. On the same day, Hanjin conducted a demand forecast for a 30 billion won public bond issuance but only raised 1 billion won, resulting in a large amount of unsold bonds. SK REITs bonds received orders for 91 billion won out of 96 billion won sought, and Meritz Financial Group and SK Rent-a-Car also failed to meet their order targets. AAA-rated public and corporate bonds are no different.

On the 17th, Korea Electric Power Corporation (KEPCO) attempted to issue 400 billion won in bonds (2-3 year maturities) offering interest rates of 5.75% and 5.9%, but 120 billion won failed to find investors and was rejected. Korea Expressway Corporation also attempted to issue 100 billion won in bonds (2-year maturity) on the same day but was fully rejected. Gwacheon Urban Corporation, a high-grade AA-rated public enterprise under local government, had 60 billion won in bonds planned for issuance at a 6.2% interest rate on the 19th, but the entire amount was rejected.

According to the Korea Financial Investment Association, a total of 16 cases (950 billion won) of unsold bonds occurred in the third quarter of this year, with an unsold rate of 14%, up 13 percentage points from the previous year. Notably, 8 cases (650 billion won) of unsold bonds occurred in the A rating category, recording a high unsold rate of 58%.

As fundraising costs rise, companies are finding it increasingly difficult to raise funds. According to the Bank of Korea, the spread between corporate bonds (AA-, 3-year maturity) and government bonds reached 1.14 percentage points on the 14th, the highest level since September 2009 during the global financial crisis. A widening spread between corporate and government bonds means it has become more difficult to raise funds through corporate bond issuance.

Han Min, Director of the Financial Market Department at the Bank of Korea, analyzed, "Due to heightened financial market uncertainty, risk premiums on credit bonds with low credit ratings and liquidity have significantly increased, shrinking investment demand. Additionally, the volume of credit bond issuance has greatly expanded this year, focusing on ultra-high-grade bonds such as special bonds and bank bonds, which has created supply-demand pressure in the market." He added, "Especially, most of the increased credit bond issuance this year has been concentrated in AAA ratings, which has limited demand for credit bonds with relatively lower credit ratings." From January to September this year, the net issuance of AAA-rated credit bonds totaled 48 trillion won, accounting for 96% of the total net issuance of credit bonds.

KEPCO Bonds and Bank Bonds as a Financial Black Hole

In particular, KEPCO bonds and bank bonds have absorbed a large amount of funds. According to the Bank of Korea, KEPCO bonds saw a net issuance of 18.3 trillion won from January to September this year, accounting for 36.7% of all credit bonds. KEPCO has been continuously issuing bonds to cover operating fund shortages due to large deficits.

Bank bonds have also been issued at record levels this year. According to the Korea Financial Investment Association, as of the 20th, banks have issued 168.649 trillion won in bank bonds this year, reaching 92.1% of last year's total issuance of 183.2123 trillion won. Bank bond issuance, which was 10.47 trillion won in April, soared to a record high of 24.71 trillion won in July this year. Last month, it reached 25.88 trillion won, setting a monthly record.

As a result, the 5-year bank bond (unsecured, AAA) yield reached 5.286% as of the 19th. This is the first time in about 12 years and 10 months since February 24, 2010 (5.24%) that it has risen above 5.2%. Short-term yields also surged. On the same day, the 6-month bank bond (unsecured, AAA) yield was 4.117%. The 6-month yield exceeding 4% is the first time in about 13 years since January 7, 2009 (4.12%).

The reason financial bonds issued by major commercial banks with AAA credit ratings have recently swept up market funds is to increase fundraising scale. A commercial bank official said, "First, it was to meet the Liquidity Coverage Ratio (LCR) required by the Financial Services Commission, and second, it was to expand fundraising to hedge the volatility of over-the-counter derivative transactions caused by the rising exchange rate."

The most representative way for banks to expand fundraising is by issuing bank bonds. However, as a result of this measure, bond yields rise, the market becomes unstable, and eventually, loan interest rates also increase. A financial sector official explained, "When commercial banks issue bank bonds to meet LCR ratios, in the current tight corporate bond market, people flock to the highly rated bank bonds, creating a financial black hole." The sequence of large-scale bank bond issuance → sharp rise in bond yields → increase in bank lending and deposit rates has destabilized the market. As commercial banks absorb liquidity like a money-eating hippo and the Gangwon-do Legoland incident occurs, difficulties in fundraising for the secondary financial sector involved in real estate project financing (PF) have worsened.

Researcher Lee Kyung-rok of Shin Young Securities analyzed, "Due to domestic and international interest rate hikes, increased interest rate volatility, sharp exchange rate rises, and recession concerns, credit bond investment sentiment has frozen, and the short-term funding market was particularly difficult amid the interest rate hike trend and concerns over real estate PF insolvency. After the Legoland incident, the short-term funding market deteriorated rapidly. The large-scale issuance of KEPCO bonds is still ongoing, banks are struggling to raise funds for various reasons, and securities firms with many real estate PF guarantees also need to secure funds proactively. The fact that cash securing is prioritized not only by companies but also by financial institutions means that the current situation is not a normal financial system."