How Kim Jin-tae and Legoland Shook the Financial Market [Song Seung-seop's Financial Light]

Midway Development Corporation Spent 205 Billion Won on Legoland Construction
Provided Guarantee... Governor Kim Jin-tae of Gangwon Province Says "Entering Rehabilitation"
Investor Anxiety Grows, Wallets Start Closing
Even Blue-Chip Corporate Bonds Fail, Bond Yields Soar
Government Struggles to Calm Market, Announces "Liquidity Supply Exceeding 50 Trillion Won"

Finance is difficult. Confusing terms and complex backstories are intertwined. Sometimes, you need to learn dozens of concepts just to understand a single word. Yet, finance is important. To understand the philosophy of fund management and consistently follow the flow of money, a foundation of financial knowledge is essential. Accordingly, Asia Economy selects one financial issue each week and explains it in very simple terms. Even if you know nothing about finance, you can immediately understand these ‘light’ stories that turn on the bright ‘light’ of finance for you.

Jin-tae Kim, Governor of Gangwon Province

[Asia Economy Reporter Song Seung-seop] The domestic financial market is shaking significantly. Bond investors have closed their wallets, and even high-quality companies are struggling to raise funds. Bond yields have soared. The crisis began with the Legoland default incident and statements by Kim Jin-tae, Governor of Gangwon Province. What exactly happened?

‘ABCP’ used to raise funds for Legoland?

The origin goes back two years. The Gangwon Development Corporation (GJC), responsible for water supply and road development around Legoland, decided to borrow money to create Tepamark. Since it was a large-scale real estate development project, a large amount of money was needed. Accordingly, in 2020, they established a special purpose company (SPC) called ‘Iwon Jeilcha’ to raise funds and issued promissory notes worth 205 billion KRW. To facilitate smooth sales, Gangwon Province provided a guarantee, and BNK Investment & Securities acted as the lead manager, purchasing all the notes and then selling them to other companies. Ten securities firms and one asset management company bought them.

The product was called ‘Asset-backed Commercial Paper (ABCP).’ As the name suggests, it is a commercial paper issued backed by corporate assets. The company borrows money using various assets as collateral, such as rights to future revenue (accounts receivable) like admission fees or land and buildings owned by the company. Iwon Jeilcha pledged ‘loan receivables’ as collateral. The structure was that GJC first borrowed 205 billion KRW from Iwon Jeilcha, and then Iwon Jeilcha issued ABCP based on the ‘right to collect money from GJC.’ The maturity date was last month 29th.

However, GJC, which borrowed the money for construction funds, failed to repay the promissory notes contrary to the contract. Investors turned their eyes to Gangwon Province, which had provided the guarantee. Gangwon Province had promised to repay the money on their behalf. But on July 7th, newly inaugurated Governor Kim Jin-tae announced that he would file for GJC’s rehabilitation with the court. Instead of preparing a budget to repay the money, he intended to have a court-appointed trustee sell GJC’s assets and use the proceeds for repayment.

Even government-guaranteed commercial papers are not trustworthy... Investor anxiety rises

Legoland Hotel Exterior View

Investors perceived Governor Kim Jin-tae’s remarks as risky. Although Governor Kim repeatedly clarified that it did not mean they would not repay the money, investors thought differently. They doubted whether they would be able to get their money back properly after investing in the bonds. This was understandable because rehabilitation procedures take a long time. It was also uncertain whether GJC’s assets could be sold at fair value to repay all debts. Even if a certain amount was repaid over several years, investors would inevitably suffer losses.

Moreover, the shock caused by the ‘local government’s guarantee failure’ was significant. Investors considered ABCP very safe because Gangwon Province had guaranteed it. They judged there was no worry about losing money unless the country collapsed. Despite controversies over the project’s viability, credit rating agencies gave it the highest ‘A1’ rating. When such a product became effectively insolvent, investors fell into panic.

Eventually, credit rating agencies also downgraded the ABCP’s credit rating. It was lowered to a C rating, indicating a ‘dangerous stage where repayment ability is uncertain.’ Consequently, earlier this month, ABCP and Iwon Jeilcha were declared bankrupt. This was the first time that ABCP guaranteed by a local government became insolvent.

The aftermath spread throughout the domestic financial market. Among investors, a sense of ‘there is no one trustworthy’ spread. If even local governments, which are unlikely to fail, cannot repay money properly despite guarantees, how much worse would bonds and commercial papers issued by private companies be? Investors closed their wallets. This added fuel to the already unstable financial market, burdened by adverse factors such as US fiscal tightening and interest rate hikes, and the Russia-Ukraine war.

High-quality corporate bonds fail to sell, bond yields skyrocket

91-day CD Interest Rate Trend

Companies that need to raise funds by issuing bonds began to suffer. On the 17th, Korea Electric Power Corporation attempted to issue corporate bonds worth 400 billion KRW with interest rates of 5.75% and 5.9% per annum, but 120 billion KRW remained unsold. Despite the company’s credit rating being AAA, the highest grade, bond investors did not purchase the bonds. Bonds worth 100 billion KRW issued by Korea Expressway Corporation (AAA rating) were completely unsold. With even the highest-rated corporate bonds facing such issues, smaller companies with lower credit ratings are finding it extremely difficult to raise funds.

Companies had to pay more costs to raise funds. They had to set higher bond yields to pay more interest to borrow money. According to the Korea Financial Investment Association, as of the 21st, the interest rate for 3-year corporate bonds (unsecured) with AA- rating was 5.736%, breaking the previous year-to-date high of 5.588% recorded the day before. The 3-year corporate bond (unsecured) BBB- rating also hit a new yearly high at 11.585%. The refinancing rates for commercial papers (CP) and asset-backed short-term bonds (ABSTB) reached their highest since the 2009 financial crisis.

The liquidity crunch in the project financing (PF) market is particularly severe. PF is a lending method used for large-scale construction and real estate projects. It is a product where loans are given based solely on the project itself rather than collateral. When Gangwon Province failed to fulfill its guarantee obligations for ABCP properly, other PF products could not be sold even with very high interest rates. The PF securitization bonds maturing by the end of this year amount to about 34 trillion KRW. If investors do not appear, securities firms and construction companies that lent money and provided guarantees could face huge losses or insolvency risks.

Despite Kim Jin-tae’s explanation, anxiety remains... Government to supply over 50 trillion KRW in liquidity

Deputy Prime Minister for Economy Choo Kyung-ho attended the 'Emergency Macroeconomic and Financial Meeting' held at the Bankers' Hall in Jung-gu, Seoul on the 23rd, and after the meeting, he is briefing the results of the meeting. Photo by Yoon Dong-joo doso7@/Photo by Yoon Dong-joo doso7@

As the problem worsened, Governor Kim held a press conference to clarify his position. On the 21st, he emphasized, “Gangwon Province will definitely fulfill the guarantee debt caused by the insolvency of the Gangwon Development Corporation, as repeatedly stated,” and “It will be fulfilled no later than January 29, 2023.” He added, “We are pushing to prepare a budget of 205 billion KRW for guarantee debt repayment within this year,” and mentioned, “This is a measure to protect individual investors in the bond market and resolve uncertainties in the financial market.”

Nevertheless, investor anxiety did not subside easily. Eventually, the government stepped in. Deputy Prime Minister and Minister of Economy and Finance Choo Kyung-ho, Bank of Korea Governor Lee Chang-yong, Financial Services Commission Chairman Kim Joo-hyun, Financial Supervisory Service Director Lee Bok-hyun, and Presidential Office Economic Secretary Choi Sang-mok held an emergency macroeconomic financial meeting at the Seoul Banking Hall. They decided to expand the liquidity supply program to over 50 trillion KRW. The purchase limit for corporate bonds and commercial papers (CP) bought by Korea Development Bank, Industrial Bank of Korea, and Korea Credit Guarantee Fund was raised to 16 trillion KRW, and a 3 trillion KRW support was provided to securities firms facing liquidity shortages.

Deputy Prime Minister Choo promised, “We will actively respond to instability in the real estate PF market,” and “All local governments will pledge purchase guarantees.”