[Funding Workaround] ③ 'BBB' Bond Yields Surge Over 3%P in One Year... Low-Credit Companies Face Inevitable Impact

National Treasury Bond Yields and Corporate Bond Spreads Rise Together
Interest Rate Gap Widens Between Investment Grade and Non-Investment Grade Firms
Double-Digit Private Placement Bond Yields for Some Construction Companies

Editor's NoteThe sharp interest rate hikes that began after the Russia-Ukraine war have left corporate finance officers bewildered. Governments worldwide, including the United States, have maintained an unpredictable stance on how long and how much they will raise interest rates. Financial stability was shaken by the Legoland incident and fears of real estate project financing (PF) defaults, causing turmoil in the funding market. In this unstable market environment, not only companies with relatively low credit ratings but also high-quality large corporations sought alternative funding routes outside of public corporate bonds, such as commercial papers (CP), private placement bonds, and bonds with options.

As market interest rates rose sharply, the interest burden on companies increased significantly, with low-credit companies that must raise funds through private bonds and bonds with options facing an even heavier interest burden. In particular, some construction companies are facing double-digit borrowing costs. There are concerns that many of these companies, due to their large debt sizes, could fall into a vicious cycle where massive interest expenses lead to deteriorating profitability, making funding even more difficult.

According to the bond market on the 4th, the private bond rating agency's evaluation yield (hereafter referred to as the private average yield) for AA-rated 3-year maturity unsecured corporate bonds, considered high-quality corporate bonds, stood at 4.07%. The private average yield for the same grade 5-year maturity bonds was around 4.32%. This marks an increase of about 1.8 percentage points from early last year, when the 3-year and 5-year maturities were at 2.42% and 2.58%, respectively. The private average yield for 3-year maturity A0-rated corporate bonds rose from 2.88% to 5.09% during the same period.

The rise in interest rates is due to the combined effect of rising government bond yields and spreads (additional interest rates) that vary according to credit ratings. The 3-year maturity government bond yield increased from about 1.85% in early last year to 3.34% recently, following interest rate hikes by the Bank of Korea. The spread for AA-rated bonds of the same maturity rose from 57.2 basis points (bp) (1bp = 0.01 percentage points) to 73.4bp.

The lower the credit rating, the greater the increase in interest rates. The 1-year maturity unsecured corporate bond yield for BBB0-rated bonds was in the low to mid-4% range early last year. It steadily rose over the year and reached the low 7% range as of the day before yesterday. Over one year, the interest rates for 3-year maturity AA-rated bonds increased by about 1.5% to 2%, A0-rated bonds by 2% to 3%, and BBB-rated bonds by 3% to 4%.

A bond market insider said, "With the worsening real estate market and deteriorating corporate earnings, concerns about a credit crisis are emerging, making it highly likely that the spread gap between high-quality and non-high-quality companies will widen further," adding, "The interest burden on corporate funding has nearly doubled from historically low levels."

Low-Credit Companies Face Even Greater Effective Funding Interest Burden

In fact, low-credit companies that primarily use private bonds and bonds with options as their main funding sources bear interest rates higher than the private average yields for the same rating. Especially, construction companies with many contingent liabilities from project financing (PF) have borrowing costs reaching double digits, forming a high level.

TY Holdings issued option-type private placement bonds to investor Kohlberg Kravis Roberts (KKR) at an interest rate of 13%. With an issuance amount of 400 billion KRW, this single bond issuance results in an annual interest burden of 49 billion KRW. Dongbu Construction also issued callable bonds at a 10% interest rate. However, due to limited investor demand, it is known to issue these in amounts less than 10 billion KRW in multiple tranches.

Kolon Global issued callable bonds at 7.926%. This is more than 2 percentage points lower than the option bonds issued by Dongbu Construction. However, compared to the past when private bonds could be issued at interest rates in the 4% range, the funding cost has risen sharply.

Mid-sized construction companies such as IS Dongseo and Isu Construction issued unsecured private bonds at interest rates of 9% to 10%. Small and medium-sized manufacturing companies like Ajin Industrial and Seojin System also issued private bonds at double-digit interest rates.

Private bond issuance interest rates for companies such as Busan Lotte Hotel, Lotte GLS, SK Shipping, AJ Networks, Deutsche Motors, and Han Express are in the 8% range. Companies like Klean Nara, Shinseong Tongsang, Taeyoung Construction, Lotte Cultureworks, CJ Foodville, LS Networks, AJ Networks, Emart 245, and Daewoo Construction have private bond interest rates in the 7% range.

An investment banking industry insider expressed concern, saying, "Most low-credit companies have high debt ratios or borrowing ratios, so when interest rates rise, interest expenses increase significantly," adding, "In a situation where corporate earnings are generally deteriorating, increased interest expenses are likely to further damage profitability."