August 2009

ABOUT THE FIRST thing one sees on arrival at Seoul’s hyper-modern Incheon Airport after entry formalities is a screen animation depicting the capital’s landmark communications tower soaring over downtown Namsan Park, as the city of 12 million sprawls beneath it.

At first glance it looks like a tourist lure for Namsan’s scenic cable-car ride through bucolic greenery overlooking magnificent cityscapes.

Look again.

The animation reveals huge hairy hands – a metaphor for the financial crisis – that suddenly begin tearing great chunks out of Namsan. The tower starts to teeter, the surrounding city is in chaos, and people are dying. It’s as if the world is collapsing, the very foundations of the country are being torn asunder.

But wait – help is at hand in the form of Hyundai Capital, the finance arm of one of South Korea’s biggest chaebols, or conglomerates. And just as the tower begins to topple, the friendlier hand of Hyundai reaches out to stop the calamitous ensemble from descending to disaster. Namsan’s foundations are quickly restored and so, too, presumably, are the nation and its apparently vulnerable wealth. The overly dramatic message is clear – Hyundai Capital will be there to save you.

It’s all a bit alarmist because, after clearing Incheon and making one’s way through Seoul’s financial community, it’s not at all obvious that South Korea’s once-brittle financial and banking system requires saving, whether by Hyundai Capital, the government or – as in the still much-discussed financial crisis of the late 1990s that virtually bankrupted the country – the IMF.

Although South Korea is not quite in the pink of health – which country is? – it certainly doesn’t feel as if it’s troubled, in imminent danger of collapse or anything but calmly seeing out the admittedly difficult times. Indeed, far from wounded and retreating as many of their US and European counterparts are, Korean banks are busily promoting their prudent balance sheets and cashing up with new international bond issues, including some made of the similar DNA that went into the US mortgage-backed securities that got us all into this mess. Except that Korean covered bonds are anything but sub-prime.

David Edwards, chief executive of Standard Chartered-owned SC First Bank, agrees. "The crisis here is nothing like it was in the 1990s," he says. "There’s been a whole slew of measures introduced and I think this is what is helping keep the economy out of recession so far."

Make that ‘just out of recession’. Despite exports slumping 18% in the first quarter of 2009, the world’s 12th-biggest exporter posted economic growth of 0.1%. It’s a close shave but Korean economists are surprised and rather pleased that the economy grew at all. GDP growth, even marginally measured, is something Korea’s fellow Asian export economies like Taiwan, Japan and Singapore couldn’t boast in Q1. The second quarter proved their optimism; GDP jumped 2.3% in the three months to June 30, South Korea’s strongest quarter since Q4 2003. The Korean government and its central Bank of Korea had warned that the economy will contract this year for the first time since the crisis in 1998, but six months in, Koreans are holding on valiantly. Bars and restaurants seem full, outwardly and anecdotally. Seoul seems lively and there’s no sign of those terrifyingly hairy hands over Namsan just yet.

Much discussion among bankers and economists in Seoul compares the impact of this current crisis to the Asian contagion that crippled Korea a decade ago and forced the country to embrace a humiliating IMF bailout. But this time it’s different. Professor Lee Doo-won of Yonsei University’s School of Economics notes: "The 1990s crisis was a crisis of insolvency. The banking sector and the corporate sector then had a debt that could not be paid back without the help of the IMF. But the crisis Korea has today is not about insolvency, it is liquidity. That means we are in much better shape."

North Korean leader Kim Jong-il’s illness has added an element of instability to relations for Seoul

South Koreans are sanguine about their economy because, compared with the catastrophe that engulfed them during the late 1990s, this crisis is a relative ripple. Much of South Korea was bankrupted in 1997/98. In each quarter of 1998, the economy contracted an average 6.65%. The Korean won weakened 25% against the US dollar last year; during 1997/98 it fell 60%.

All about exports

It’s all about exports, and that means it’s mostly about China. Professor Lee notes that Korean exports fell less sharply during the first quarter this year than those of competing exporters. Year on year, Korean exports fell by 35% in January and 18% in February. It was savage but not as severe as Japan’s 48% slump and China’s 25% decline in February. Lee attributes that "relatively mild" decline to Korea Inc’s stronger market position in developing markets less affected by the financial crisis. Since the first quarter, he says, exports have risen encouragingly to these less-developed markets, where Korean goods are priced as more prestigious than mass-market Chinese-made goods but not as expensively as western imports. He means neighbouring China, which, he says, will save South Korea. China is now Korea’s biggest export market and is buffering the Korean decline. Lee expects Chinese growth to come in at around 8% this year, better than most western forecasts. "Korea will enjoy the biggest benefit of this growth among China’s trade partners," he says.

This closer-up impact of the China factor has prompted various analysts to revise their forecasts of Korean GDP in 2009. The central Bank of Korea had originally tipped a 3.3% decline this year – it has now revised that to a 2.9% decline. Likewise Goldman Sachs – from a 4.5% decline to a 1.7% slump – and UBS too, which had forecast a 5% decline at the beginning of 2009 but now expects a 3.4% fall. The Korean finance minister, Yoon Jeung Hyun, has said he expects a decline of 2% in 2009. Yonsei’s Professor Lee says: "I think we have hit the bottom. Under the bottom there is a basement but I don’t think we will have to go there."

Korea has been a good play for foreign investors so far this year. The stock market’s Kospi index has rebounded around 30%, its upward climb almost mirroring the strengthening of the won, a double bonus for investors. "There’s been some quick and easy money out of the Korean capital markets," says Lee. The bond market has been nicely buoyant too.

Lee continues: "At the end of last year, the problem we had was to stabilize foreign exchange markets as fast as we could. After the Lehman collapse, the Korean government was not ready to deal with any panic situation, and that resulted in some chaos toward the end of last year. However, that stabilized after the currency swap agreement between Korea and the US, which helped stabilize our exchange rate.

"Then we turned attention to the domestic financial sector; we had to make our banking sector stronger and healthier, we had propped up our BIS [risk-bearing capital and the risk-weighted asset] ratios and that happened. That was the second stage. Right now we are in the third stage of recovery, where we need to restructure our corporate sector. It will take time, it can be painful because it can generate unemployment – that is something we need to do.

"We need to do this to get into the next stage of revitalizing domestic demand, consumption and investment. Without restructuring the corporate sector, it will be very difficult to expect consumers to spend more and companies to invest more." Lee says the Korean government has done much to assist in the restructuring of the corporate sector, largely by generating jobs in the public sector and securing social safety nets.

The stresses on the Korean won were evident in September last year when the spread on the government’s forex stabilization bond rose from 150 basis points in late August to almost 600bp after the Lehman collapse. Then, through September and October, the Bank of Korea chewed up almost $50 billion of its $260 billion reserves pile trying to defend the won. But by October 30, Seoul and Washington agreed a currency-swap deal that immediately sent the bond spreads tumbling back toward 300bp. That eased pressure on the local banks and by January Korean banks had successfully rolled over billions of dollars of foreign debt exposure. Since then, the economy has resumed accumulating current-account surpluses, further stabilizing local-currency markets. Foreign reserves evened out at about $200 billion in December and January and have now edged up towards $220 billion.

"The crisis here is nothing like it was in the 1990s. There’s been a whole slew of measures introduced and I think this is what is helping keep the economy out of recession so far" David Edwards, SC First Bank

Kim Jin-kyung, chief financial officer of the Export-Import Bank of Korea, describes the market reaction to the spreads of Korean bonds in the immediate aftermath of the Lehman collapse as "extreme". He says that Korean paper has been "unfairly treated" by the market.

"When we did the first issue out of Korea in January, it was also to show the world that funding was available for Korean issuers, it was just a matter of pricing," Kim says. "At that time, money was very expensive for us but we did manage to make quite a sizeable issue, and since then the spread has come down considerably.

Money available

"If we can pay the price, there is money available for us. The availability problem has now completely disappeared." He says market conditions for Korean issuers in US dollars have eased, but that euro and samurai bonds remain "comparatively expensive for us, so for the time being we are focused on the dollar side."

Despite on-off policy initiatives such as the currency-swap deals, bank deposit guarantees and last November’s $11 billion government stimulus package, Lee acknowledges that a "much healthier corporate and banking sector" – more influential than direct government action – has enabled Seoul to keep game-changing foreign gremlins at bay from substantially destabilizing the economy during this crisis. He says the average capital adequacy ratios in Korea – between 12% and 13% – are much higher than in fellow OECD member states. As for the government, Lee said it had panicked at the onset of the crisis but now is "heading toward the right direction".

And in perhaps the most ringing endorsement of all, the world economy’s current Dr Doom, Professor Nouriel Roubini of New York University – one of the few economists who predicted the financial crisis and who is notorious for his residual pessimism – thinks the Korean economy will outperform most forecasts in 2009/10. "The latest economic indicators suggest there is the beginning of an economic recovery and growth might be already positive in the second quarter,’’ he says.

Against this comparatively buoyant backdrop, South Korean bankers still have their reputations intact and have begun launching financial products that remain years away from reappearing in the west, if they ever surface again.

That’s evident in the first covered bond launched in Asia since the financial crisis. HSBC and Citibank have helped South Korea’s biggest private bank, Kookmin, arrange a $1 billion bond covered by its mortgage and credit card portfolio. It’s a structure that might send chills through Wall Street and the City of London but the Korean version comprises anything but the overleveraged Deadbeat dad or ghetto loans packaged into the US nightmare.

Kookmin’s mortgages are solid Korean middle class; few Koreans owe their bank more than 50% of the conservative value of their homes, a regulation instituted after the 1998 crisis. Dr Lee Sang-che, research fellow at the Korean Institute of Finance, notes: "The Korean mortgage sector is one of the healthiest in the world, with small volume and low delinquency ratios, below 1%. Its loan-to-value (of the property) ratio is around 40%."

More to the point, the five-year Kookmin facility was six times oversubscribed. About 55% of it was taken up by Asian investors – further evidence, if any were needed besides China’s huge continued flotation of the US economy, that the future indeed tilts eastwards.

"I think the success of this bond shows there’s a good appetite for this type of product out there if structured properly" Will Ross, HSBC

ING and Barclays Capital had an early mandate from Kookmin Bank – in which ING holds a direct 5% shareholding – to execute the covered bond. Although ING didn’t eventually carry the Kookmin deal to the end, Plag tips his cap to competitors HSBC and Citibank for getting the issue away. "It was very well received," he says. Plag notes that the Kookmin bond had a large credit card element to the structure. "Credit cards have a great record here in Korea," he says, noting cardholders’ low delinquency levels. "People here always pay their monthly bills when their salary comes in. It’s much stricter here." Plag interprets this as a legacy of the 1999 to 2002 credit card binge in South Korea, when issued credit cards doubled, a boom that ended in tears in 2003 in billion-dollar bailouts for a host of issuers. "They were handing out credit cards for free and people were paying their debts of one with another." Plag says US credit bingers that contributed to the current crisis could learn a lesson from Korea. "I think people learnt their lesson then."

Plag also notes a keener pricing for the Kookmin bond compared with similar eurobonds issued in Eastern European markets. "Everything has its price and, rightly or wrongly, Korea is still seen as an emerging market and that comes at a price. It [the Kookmin bond pricing] could have been much worse. It was a decent price, and there was solid interest and it was well received."

While acknowledging the success of the Kookmin package, Standard Chartered’s Edwards says: "I don’t have any plans to do a covered bond but I would like to do some more RMBS [residential mortgage-backed securities]."

Permanently penalized

Cho Syeung-hyun, chief of the global funding team at state-owned Korean Development Bank, says Korean paper has in recent years been more keenly priced in the market than issues from the Philippines, long regarded as a southeast-Asian basket-case economy. "The ongoing North Korea nuclear impasse is a constant problem for Korean issuers that perennially overhangs the market’s view of Korea," Cho says. "South Korea is permanently penalized by geopolitical reasons in how it is rated, so don’t tell us we have to pay more compared with other single-A issues." Based on the relative health and size of the economy, Cho says, "we should be at least double-A. We continue to educate investors."

The market has also been buoyed up by the winning of a long-standing investor campaign to have a withholding tax on won-denominated Korean bonds lifted, a further sign that the government is listening more closely to the market. While welcoming the relaxation, Adam McCabe, fixed-income portfolio manager at Aberdeen Asset Management, wonders if it will have any impact on improving liquidity and foreign participation in the won market. "I don’t think it will have a dramatic impact in the short term," he says. "It doesn’t immediately drive foreign capital into the market." McCabe says further education and selling of policy needs to be made by the authorities to widen the appeal of Korean bonds, with the resultant impact on liquidity.

"The liquidity of the domestic bond market is quite disappointing," he says, noting a succession of "fire sales" of Korea-related bonds in recent months in response to the financial crisis buffeting from abroad, which might have affected foreign "comfort levels" toward the local Korean capital markets. "We need to undergo another round of education so foreign investors can better understand the local market."

McCabe agrees that the Korean market had been unfairly treated internationally. "A lot of people didn’t fully appreciate the nature of the risks in the local financial system. Those [Korean] issuers that have come to market in the past six months have done a fantastic job in educating the international investing community. Korea does get an unfair press sometimes."