[Bond Market Diagnosis] Same A Grade? Only Companies with Supportive Backing Enter the Corporate Bond Market

Financial Groups and Large Conglomerate Affiliations, Earnings Outlook Determine Fortunes
February FOMC and Interest Rate Policy Changes as Variables
Watch for Funding Tightening in Construction, Chemical, and Securities Sectors with Low-Credit Companies

[Asia Economy Reporter Hwang Yoon-joo] #1. Hyosung Chemical (A) left an embarrassing record of zero orders in its corporate bond demand forecast on the 17th. It attracted attention as the first A-rated credit bond of the year, but investors ignored it.

#2. On the 18th, Shinsegae Food's (A+) demand forecast was a great success considering its credit rating. It received orders about four times the issuance amount. Although it is rated A, the high demand is expected to result in an issuance interest rate 10 basis points (1bp=0.01 percentage point) lower than the average market rate (the unique rate evaluated by private bond rating agencies).

#3. Hana F&I (A) also recorded a hit in its demand forecast on the 18th, attracting funds about eight times the issuance amount. Although it has the same rating as Hyosung Chemical, 660 billion KRW in orders poured in for an 80 billion KRW demand forecast.

Only companies capable of raising funds appear in the corporate bond market

Since the new year, the fortunes of 'A' credit bonds in the bond market have diverged. Even though they share the same A rating, it might be easy to think that demand forecast results differ depending on whether the outlook is positive or negative, but the current market perspective is somewhat different. Only companies with a solid backing?such as parent companies or affiliates that can provide emergency funding, strong financial holding subsidiaries, or industries with decent performance outlooks?are stepping up to raise funds.

Hyosung Chemical hoped to issue 120 billion KRW in corporate bonds but received no orders from institutional investors. Although Hyosung Chemical is part of a large conglomerate, it carries a 'negative' outlook tag on its credit rating, and its business and performance outlooks are poor, with consecutive quarterly losses. Industrial Bank of Korea, which lent money to Hyosung Chemical, and the bond issuance underwriters KB Securities and Korea Investment & Securities absorbed the undersubscribed portion. Although it failed to attract demand, it ultimately succeeded in raising funds.

Shinsegae Food received orders worth 195 billion KRW against a 50 billion KRW issuance target. The issuance interest rate is also expected to be set about 10 basis points lower than the average market rate. Investors flocked due to Shinsegae's strong cash mobilization capability and the company's status as a provider of essential consumer goods (food ingredients). Hana F&I, which buys distressed bonds cheaply and bundles them with slightly better loans to resell, also recorded a huge success. Being part of Hana Financial Group and having a business nature that is more promising during recessions, it received orders of 660 billion KRW for an 80 billion KRW issuance.

A bond executive at a securities firm explained, "Although the demand forecast results for Hyosung Chemical, Shinsegae Food, and Hana F&I differed, they all share the commonality of having a reliable backing to enter the market," adding, "If it is thought that no one will take on the issuance volume like in Hyosung Chemical's case, the atmosphere is that the company cannot even come to the market."

A-grade bonds require backing, but AA-grade or higher (superior) bonds are different. Since last year's Legoland incident, the bond market has regained warmth due to government market stabilization measures, and superior bonds are extremely popular. Institutional investors poured funds into demand forecasts for KT (AAA), E-Mart (AA), POSCO (AA+), LG Uplus (AA), and Lotte Confectionery (AA) that came to the corporate bond market this year. Notably, POSCO broke KT's record the day after KT raised the largest amount ever in the public corporate bond market. POSCO's demand forecast for 700 billion KRW received 3.97 trillion KRW in orders. Institutional investors bet this way expecting that interest rates will not rise further or will fall, aiming to secure stable fixed income.

Construction, chemical, and securities sectors find it difficult to cross the corporate bond issuance threshold

[Image source=Yonhap News]

Of course, this applies only to (superior) bonds. In the bond market, non-investment grade bonds with unstable funding conditions still cannot even cross the market threshold. A credit rating agency official explained, "Legally, 'BBB' and below are speculative grades, but when a recession is expected, the market treats even 'A' grade corporate bonds, which are vulnerable to volatility, as speculative grade," adding, "Especially sectors like construction, chemical, and securities are avoided in the credit market."

The market particularly views the construction sector as a watchlist due to the real estate project financing (PF) risks that shook the bond market last year.

Among the top 10 domestic construction companies, six are rated 'A' and the rest 'AA'. These include Samsung C&T (AA+), Hyundai Engineering & Construction (AA-/Stable), GS Engineering & Construction (A+/Stable), POSCO Engineering & Construction (A+/Stable), Daewoo Engineering & Construction (A/Stable), Hyundai Engineering (AA-/Stable), Lotte Engineering & Construction (A+/Negative), DL E&C (AA-/Stable), HDC Hyundai Development Company (A/Negative), and SK Ecoplant (A-/Stable).

The problem is that the largest portion in the public corporate bond market is made up of 'AA' and 'A' ratings. According to the Korea Financial Investment Association, in 2021, the issuance share by credit rating was AA (36.4%), A (14.7%), AAA (10.7%), and BBB (4.2%). 'AA' and 'A' ratings accounted for half of the total issuance volume.

Last year, the order was AA (39%), AAA (16.5%), A (9.7%), and BBB (3.6%). A Korea Financial Investment Association official explained, "During last year's liquidity crunch, funds flowed more to high-quality companies than to companies rated A or below, which are considered non-investment grade."

This is a natural movement in the market. There is no reason to invest in unstable places. From this perspective, there are calls for the government to act to prevent maturity refinancing or new funding from being blocked in certain industries. A financial industry official said, "It is one thing for individual companies to undergo restructuring according to market logic and another for an entire industry to face a crisis due to liquidity crunch," adding, "We must be careful to prevent investors from avoiding certain industries and causing even healthy companies to suffer crises."

Government support for the corporate bond market... Need to prepare for liquidity crunch in specific industries

[Image source=Yonhap News]

Since announcing market stabilization measures worth '50 trillion KRW + α' last year, the government continues to monitor market conditions this year through emergency macroeconomic and financial meetings.

There are two main programs for the corporate bond market. First is the corporate bond and CP purchase program. It is about 7.6 trillion KRW in scale, with funding support from the Industrial Bank of Korea and the Korea Development Bank. It mainly purchases non-investment grade corporate bonds.

The second is the Primary Collateralized Bond Obligation (P-CBO) program. It collects bonds from companies with low credit ratings that find it difficult to issue corporate bonds, then issues bonds backed by guarantees from institutions like the Korea Credit Guarantee Fund. Previously, support was provided for ratings from A- to BBB-, but the support target has been expanded to BB- or higher for general companies and BBB- or higher for credit finance companies.

The Special Purpose Vehicle (SPV) for corporate bond and CP liquidity support, introduced during COVID-19, is not currently operating. Unlike in 2020, there is no shortage of money in the bond market now.

However, so far, warmth has only spread to the lower end of the bond market. Many variables remain before it spreads to the upper end. Above all, the direction of interest rates is key. Investment sentiment could change depending on the rate hike magnitude at the February Federal Open Market Committee (FOMC) meeting. The market is betting on rate cuts within the year. The market interest rate inversion phenomenon continues, where market rates fall below the base rate. The 3-year Treasury bond rate has been below the base rate (3.50%) for four consecutive trading days from the 13th to the 18th after the Bank of Korea's Monetary Policy Committee meeting.

The recession is also becoming visible. Exports from January 1 to 10 (provisional customs clearance basis) amounted to 13.862 billion USD, down 0.9% from the same period last year. Exports have been in decline for three consecutive months since October last year.

There are also expectations that credit ratings of major companies in construction and chemical sectors may fall further depending on economic fluctuations. Investment sentiment for non-investment grade bonds is likely to freeze further. Calls to guard against liquidity crunches in specific industries may grow louder.