Korea Credit-Linked Notes Jump to Nine-Month High After Rate Cut

Sales of structured notes tied to South Korean government bonds surged to a nine-month high after the central bank unexpectedly cut interest rates, spurring demand for higher-yielding investments.

Issuance this month jumped more than five-fold to $274 million from April, the most since $592.7 million of sales in August, according to data compiled by Bloomberg. HSBC Holdings Plc (HSBA), Barclays Plc and Standard Chartered Plc (STAN) issued the notes in May. The credit-linked securities pay investors a higher coupon than the underlying debt in exchange for transferring default risks to investors.

The Bank of Korea cut the benchmark seven-day repurchase rate to 2.5 percent from 2.75 percent on May 9, the lowest level since December 2010. Six of 20 economists surveyed by Bloomberg News predicted the move while the remainder had forecast no change. The country’s 10-year sovereign debt yielded 3.09 percent as of May 31, as much as about 120 basis points less than what the credit-linked notes with a similar maturity can pay.

Investors can “get a yield pick-up by going long Korean sovereign risk,” William Shek, the co-head of rates for Asia-Pacific at HSBC, said in a phone interview. “There’s always a group of investors, in particular those in Korea, that monitor for this kind of opportunity.”

In the two days from May 13, HSBC sold $87 million of 10-year notes that pay a fixed 3.62 percent coupon in U.S. dollars and $17 million of securities with the same maturity that earn 3.58 percent a year. The buyers are mostly South Korean institutional investors who typically purchase U.S. dollar assets, Shek said.

Market Volatility

Standard Chartered, via its South Korea brokerage unit, sold a combined $70 million of notes in two offerings on May 8 and May 13, Bloomberg data show. The earlier 10-year securities, totaling $40 million, yield a fixed 3.15 percent while the other 15-year notes pay 3.95 percent for days when the three-month dollar London interbank offered rate is less than 6 percent. The benchmark was at 0.275 percent on May 30.

Barclays’s 10-year, $100 million notes issued May 28 earn 4.3 percent annually as long as the Euro Stoxx 50 Index is above 1,800 for half the interest-accrual period or more.

Sales of South Korea-linked notes increased after the cost to insure South Korean government debt against non-payment spiked amid heightened tensions with North Korea. Five-year credit default swaps on the nation’s debt touched a more than six-month high of 88 basis points on April 8, according to data provider CMA. The swaps have declined 13.5 basis points since then through May 30.

Moody’s Investors Service grades South Korea at Aa3, its fourth-highest rating, with a stable outlook. Also rated Aa3 by the ratings company are Saudi Arabia, China, Chile and Japan.

“Whenever CDS are sold off to the level where this group of investors feel it’s cheap to buy, some clients express their interest” in credit-linked notes tied to South Korean government bonds, Shek said. “Since they’re bullish on Korean fundamentals, they’re basically taking advantage of market volatility.”

To contact the reporter on this story: Jun Yang in Hong Kong at jyang180@bloomberg.net

To contact the editor responsible for this story: Katrina Nicholas at knicholas2@bloomberg.net

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