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Korea Lures Investors as Covered Bonds Dwindle: Mortgages

South Korea Lures Investors as Covered Bonds Dwindle
Swelling household debt, of which mortgages account for about 42 percent, is the biggest risk to South Korea's financial system. Photographer: Jean Chung/Bloomberg

Global investors are looking past record household debt and falling property prices to pile into South Korean mortgage bonds as a lack of supply in the world’s biggest markets boosts the allure of the securities.

Korea Housing Finance Corp., the state-run home loan provider, sold $500 million of covered bonds due September 2018 last week, according to data compiled by Bloomberg. Investors bid for more than $1.7 billion of the securities, a form of bank financing backed by mortgages and guaranteed by the issuer, with buyers from Europe and the U.S. purchasing 55 percent of the debt, said a person familiar with the matter who asked not to be named because the details are private.

Global offerings of covered securities, a form of financing pioneered in 18th-century Prussia, are off to the slowest start to a year since 2009 as investors shy away from assets mired in Europe’s fiscal crisis and banks reduce their funding requirements. Investors are instead turning to Australia, Latin America and South Korea, where forecast growth of 3.25 percent in 2013 is about triple the developed-market average.

“Covered bond investors are very interested in the Asian growth story,” said Ted Lord, the Frankfurt-based head of European covered bonds at Barclays Plc. “If you are a German insurance company, a French asset manager, or a U.K. pension fund, there is an attraction to diversify and expand investment in the region.”

Politicians in Asia’s fourth-largest economy are working on a legal framework to spur sales of covered bonds, which typically have higher credit ratings and pay lower premiums than senior unsecured debt.

Global Demand

Australian lenders sold their first covered notes in 2011 after the government passed rules permitting the securities. Chile approved legislation for the debt in September. Countries from Singapore and Japan to Brazil and Romania are considering covered bond rules.

Swelling household debt, of which mortgages account for about 42 percent, is the biggest risk to Korea’s financial system, according to a Bank of Korea survey of 90 experts and fund managers in January. Money owed by households rose to a record 959.4 trillion won ($884.7 billion) in December, central bank data show.

Residential property prices have fallen for eight consecutive months, the longest streak of declines since the period ended January 2005, according to data compiled by Kookmin Bank, the country’s largest mortgage lender, as of Jan. 31. Seoul home prices dropped 2.9 percent in 2012, the most in 14 years. Almost half the nation’s 50 million people reside in the capital and surrounding areas.

Borrowing Costs

“I don’t see imminent risks in Korea’s housing market or household debt, but if something goes wrong with the economy and the real estate market faces turmoil, given the high level of household borrowing here, nothing is free from risk,” said Kim Hyung Suk, head of the structured finance team at Korea Investors Service Co., a unit of Moody’s Investors Service. Covered bonds will help lenders cut foreign-currency borrowing costs, he said.

South Korea’s cabinet passed a draft of the bill that sets up a covered bond framework on Jan. 29. The act will be enforced six months after gaining parliamentary approval.

The banking regulator hopes the securities will give homeowners access to longer-term fixed-rate mortgages, reducing the potential damage of an interest rate shock, Fitch Ratings said in a Feb. 1 statement.

‘Big Interest’

Global offerings of covered bonds fell 24 percent last year from a peak of 387.5 billion euros ($506.5 billion) in 2011, according to data compiled by Bloomberg, leaving investors searching for debt to maintain their portfolios. Residential mortgage-backed securitizations, sales of notes that are also supported by home loans, may slide 22 percent in Europe this year, according to a January report from Barclays Plc.

The ratio of consumer debt to gross domestic product was 33.7 percent in Korea as of Dec. 31, compared to 88.7 percent in the U.K. and 73.6 percent in the U.S., data compiled by the Central Intelligence Agency show.

“There should be a big interest in non-European assets because Europe and the U.S. are so indebted and that’s not the case in Asia,” said Bernd Volk, head of European covered bond research at Deutsche Bank AG. Particularly in the euro-denominated covered bond market, “you have lower supply and you have a growing investor base so it’s obvious to me that any kind of issuer will be able to issue, it’s only a question of spread and rating.”

Bond Yields

Kookmin Bank, Korea’s debut issuer of the notes in 2009, sold them under a securitization law that was designed for RMBS rather than covered debt. KHFC differs from other Korean lenders in that its act of incorporation supports covered bond sales. No other lenders from the Asian nation have attempted offerings.

KHFC’s securities were priced to yield 100 basis points more than Treasuries, data compiled by Bloomberg show. JPMorgan Chase & Co., the largest U.S. bank by assets, priced five-year senior unsecured notes at a 103 basis-point spread on Jan. 17.

Investors demand an average 0.98 percent to buy dollar denominated covered bonds compared with 1.05 percent at the end of the year, according to Bank of America Merrill Lynch U.S. Covered Bond index. The yield investors demand to buy the securities was as high as 7.7 percent on June 2009.

Lending Slows

Park Geun Hye, Korea’s new president, has said she’ll revitalize the country’s economy and “normalize” the real-estate market. Mortgage lending in Korea climbed at the slowest pace in five years in 2012, according to central bank data.

“With the weak real-estate market now, we won’t likely see explosive demand for covered bonds from the issuers’ side at the beginning,” said Min Dong Won, a credit analyst at Hyundai Securities Co. “It’d definitely be a nice extra tool to have for banks for cheaper funding, but issuance will be contained to some extent so long as the real-estate market remains sluggish.”

Low loan-to-value ratios provide some cushioning against the risk of high household debt and falling property prices, Moody’s wrote in a January report, adding that the credit quality of mortgages will remain stable in 2013.

“Among many investors around the world, there is an upbeat view on the Korean economy and the Korean banks,” said Barclays’ Lord in an interview in Seoul in January. “These investors have an interest to diversify their portfolios and are very familiar and comfortable with the covered bond asset class.”

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