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Tuesday, 12 December 2017

All eyes on Asia

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Having been introduced as long ago as 1890 in Germany and actively issued in 22 European countries it seems extraordinary that Asia’s first covered bond was issued only in May. Educating investors about a new product was always going to prove a challenge but Kookmin's deal took the continent by storm, heralding what is likely to be a boom in covered bond issuance from Asia. Jonathan Rogers Reports.

The delay in introducing covered bonds to Asia has been blamed on the lack of a legal framework and regulations backing covered bond issuance in the region. But that theory has to a certain extent been undermined by Kookmin Bank’s ability to bring its deal, despite a lack of a covered bond law in South Korea, by utilising its ABS legislation.

Given the success of Kookmin’s deal and the obvious attractiveness of the asset class, it seems likely that covered bond issuance in Asia will take off. European investors have long extolled the virtues of the covered bond, citing the instrument’s high credit quality (issuance generally comes with a higher credit rating than the sovereign rating of the issuer’s domicile country), standardised format and large issue sizes. All this contributes to strong liquidity.

Regulators are also keen on the instrument because there has never been a covered bond default, while any problems can usually be detected early in the asset pool. Given Asia’s vast infrastructure needs over the next decade, and its desire to develop residential property ownership, the instrument could prove invaluable. It can also reduce the financing burden at the sovereign level.

Cheaper and longer

Kookmin’s deal came via Citigroup and HSBC. “By issuing a covered bond were able to retain our independence rather than relying on the government guarantee,” said Kookmin Bank CEO Kang Chung-won – a guarantee that would have cost 70bp for offshore issuance. “We could price at a longer tenor than the three years imposed by the use of the government guarantee.” The deal came with a five-year tranche supplementing the three-year.

The senior paper, issued by KB Covered Bond First Securitization, is guaranteed by KB Covered Bond First International. The SPV is incorporated in Ireland and is secured by a pool of residential mortgage loans and credit card receivables that will always exceed the bond’s value. As with all covered bonds, investors have recourse to the bank's balance sheet. But there is a further enhancement: a requirement that Kookmin top up non-performing loans in the pool with performing ones.

“The bonds are supported by a relatively typical asset-backed securitisation structure. This asset-backed structure seeks to match the cash inflow from the asset side with the cash outflow needed on the liability side,” wrote S&P analyst Frank Lu in a ratings note ahead of issuance. “The structure does not rely on the market value and the refinancing capability of the trust assets.”

Kookmin has a US$1.5bn-equivalent mortgage portfolio, more than sufficient to support the deal’s 75% subordination requirement. Demand and the ultimate deal size will determine the exact balance between mortgage and credit card receivables.

S&P rated the paper AA, compared to the issuer’s A rating from S&P (or A+ by Fitch) and the sovereign’s A2 rating, clearly demonstrating the covered bond’s superior ratings dynamic. While the risk on the securities remains with Kookmin, the deal comes with an ultra-conservative LTV of 48%, and includes hedging of won exposure via a currency swap.

Well received

The US$1bn five-year deal was indicated in Asia hours at mid-swaps plus 525bp but bankers involved signalled this guidance would be tightened as New York came in. It opened at 515bp/510bp and by 9am had tightened to 495bp/492bp. By 10am it was in at 494bp/492bp and by the late afternoon settled at 475bp/472bp, for a quick 2.5 points gain for investors, or a handy US$125,000 on a US$5m ticket. South Korean insurers and pension funds, unable to subscribe to the deal in the primary, were jumping at the chance to book Double A assets, since there are no assets available of this credit quality in Korea. But this sharp tightening prompted rival bankers to proclaim the deal had been offered too generously. The leads cited the need to leave sufficient yield on the table, given the fact this was the product’s Asia debut.

The deal amassed a staggering US$6bn book, a testament to the hard work educating investors about the deal’s structure on the road. US investors had been nervous, having seen BofA covered paper skyrocket from Libor plus 30bp-odd launch levels to around the 350bp mark. Most investors were wary of stepping outside the sovereign/quasi-sovereign space. But a coterie of investors were convinced that a senior unsecured five-year from Kookmin would need to be priced at the mid-swaps plus 600bp mark, and therefore saw value for the structured product at 700bp – or even as high as 800bp.

Others were willing to value the deal against the outstanding quasi-sovereign Kexim and KDB five-year deals which were at around the plus 450bp while the deal roadshowed. They saw value in any pickup over these levels, particularly given the Double A rating on the paper – two notches above Korea’s sovereign rating.

There was talk of including a US$200m three-year FRN into the deal. This was partly to offset the risk of early payment on the large number of the credit card receivables in the asset pool which would create a negative carry for Kookmin, which must place those funds on deposit at a low rate for the life of the bond.

Chunky reverse enquiry also motivated the pursuit of the FRN idea, but it ultimately fell away, prompting the floater plan to be dropped.

The leads were keen to stress the credit enhancement offered by the product, rather than marketing it as a pure rates instrument. Undoubtedly the generous collateral coverage made it a no brainer for accounts which would have been willing to book a senior unsecured Kookmin deal.

Perhaps one of the deal’s more impressive aspects was the bulk placement to asset managers, who ended up with 49% of the paper. Private banks liked the high coupon as an alternative for their customers to bank deposits and took 19%. Banks booked 15% and insurers and pension funds 7%. And with 58% of the deal staying within the region, the stage looks set for more covered bond deals in Asia.

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