Europeans Spurn Zero Rates for Korean Dollar Bonds Yielding 2%

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European Central Bank stimulus policies are pushing the region’s investors into dollar debt from South Korea, where they say they can find higher returns and safer credits.

Funds from the continent bought 30 percent of $700 million in five-year notes sold last week by Industrial Bank of Korea, a person familiar with the matter said. That compares with 17 percent at a similar sale in July 2012. Europeans took 31 percent of 2020 debt issued by Export-Import Bank of Korea in January, up from 21 percent at an August 2014 offering.

At a time when ECB President Mario Draghi’s bond buying has sent some euro-area yields below zero, Korean investment-grade dollar debt offers 2 percent, Bank of America Merrill Lynch data show. Demand has been supported after the outlook on Korea’s Aa3 sovereign rating was raised to positive by Moody’s Investors Service on April 10 due to improved public debt management. Supplies are limited as offshore bonds sold by Korean issuers fell about 40 percent this year, Bloomberg-compiled data show.

“The rating outlook improvement is a positive psychological step that supports positive investor sentiment towards Korea,” said Sergey Dergachev, a senior portfolio manager in Frankfurt at Union Investment Privatfonds GmbH, part of Germany’s Union Investment Group that oversees 232 billion euros ($248 billion) of assets. Korea “offers better fundamental metrics than some of its European peers, but still offers some attractive yield pick-up versus its developed market peers.”

Wider Spreads

The average yield premium on investment-grade Korean corporate bonds was 97 basis points more than sovereign notes, compared with a 42 basis point spread for developed market debt, according to Bank of America Merrill Lynch indexes.

Industrial Bank of Korea, rated Aa3 by Moody’s, the same level as the government, sold the 2 percent 2020 U.S. dollar notes at 75 basis points more than Treasuries.

Central banks took 20 percent of the bonds, while insurers and pension funds bought 30 percent, a person familiar with the matter said.

Increasing purchases by high-grade investors from Europe and the U.S. show the lender’s investor pool is widening, according to Kim Gyu Sup, the head of the bank’s international finance team. The Seoul-based lender increased the issue size from the initially planned $500 million, he said.

Where’s Korea?

“This pretty obviously shows an upgraded perception of Korea,” Kim said. “Back in 2012 an investor in Australia even asked me where Korea was located.”

Credit-default swaps insuring South Korea’s sovereign debt against non-payment for five years fell five basis points from Dec. 31 to 49.6 basis points on Wednesday, according to data provider CMA. That compares with a five basis point gain for China, which shares Moody’s Aa3 rating, the fourth-highest.

Standard & Poor’s sees a one-in-three chance of upgrading Korea’s rating in a year or two, Kim Eng Tan, a sovereign credit analyst at the rating company said this month. S&P grades the nation’s debt A+, the fifth-highest score, and raised the outlook last September.

Korea’s gross domestic product rose 0.8 percent from the previous quarter, when the economy expanded at the slowest pace since 2009, the Bank of Korea said Thursday. That compares with the median estimate of economists surveyed by Bloomberg for a 0.6 percent expansion.

Korea’s ratings have been slightly lower than its finances suggest because of “geopolitical risks, which have occasionally flared up but never resulted in any material damage so far, financially or otherwise,” said Pierre Faddoul, the credit research coordinator for Asia-Pacific at Deutsche Asset & Wealth Management in Singapore.

Fed Risk

Faddoul’s firm has become more neutral on Korean spreads over the short term due to the tightening of yield premiums so far this year, he said on April 17. That compares with an outperform recommendation about a month ago.

Long-dated Korean bonds are preferable over short-dated bonds as a potential U.S. interest-rate increase approaches, according to Shankar Narayanaswamy, the head of credit strategy at Standard Chartered Plc in Singapore. The Federal Reserve will raise interest rates in about eight months, according to a Morgan Stanley index.

Shinhan Bank sold $600 million of five-year bonds at a 92.5 basis point premium this month, while Doosan Heavy Industries & Construction Co. offered $500 million of notes guaranteed by Kexim at a 95 basis point spread. Other borrowers in the pipeline to sell dollar bonds include Korea Resources Corp., Korea Hydro & Nuclear Power Co., Nonghyup Bank and Kookmin Bank, according to people familiar with the matter.

European Demand

European participation in the Korean bond market had been falling before the ECB ramped up stimulus in March.

Funds from Europe, the Middle East and Africa dropped to 17 percent as of November last year, from 18 percent in 2013 and 19 percent in 2012, according to Bank of America Merrill Lynch research. U.S. investors led the way with 44 percent of purchases as of November 2014, it said.

“Given the large QE currently under works in Europe, European investors are looking for alternative high grade assets and Asia gives them the best options outside of the U.S.,” said Standard Chartered’s Narayanaswamy.

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