China Defaults Prompt Biggest Korea Fund to Spurn Deposit Debt

  • Chinese deposit-backed debt sales surged 80% in Korea in 2015
  • China debt markets `aren't in good shape,' Samsung Asset says

South Korea’s biggest asset manager has stopped buying securities linked to Chinese bank deposits as a slowdown in the world’s second-largest economy boosts credit-market risks.

QuickTake China’s Debt Bomb

Interest rate cuts by China’s central bank and the yuan’s drop have made notes that put Korean funds into time deposits at China’s five biggest lenders less appealing, after sales surged 80 percent last year to a record 47.8 trillion won ($39.2 billion), according to data from a local affiliate of Moody’s Investors Service. The products, sold through special-purpose vehicles created by Korean brokerages, typically mature in less than a year and carry yields of about 2 percent after hedging for currency moves. That compares with a 1.5 percent yield on similar-maturity won government debt.

“We no longer buy debt backed by Chinese bank deposits because of the nation’s economic slowdown,’’ said Kim Si Heon, a fixed-income fund manager at Samsung Asset Management Co. in Seoul, the nation’s biggest money manager with 204 trillion won of assets. “China’s credit markets aren’t in good shape overall and there are increasing concerns about corporate defaults.’’

Any pullout of cash from Korea would be another piece of bad news for Industrial & Commercial Bank of China Ltd. and the rest of the big five, already struggling for funds after an estimated $1 trillion of outflows from the nation in 2016. China’s slowing economy, falling currency and plunging stock markets have already caused losses on derivatives sold to Korean investors amid record low local bond yields and range-bound stocks.

Higher Rates

Chinese bank deposit-linked paper became popular in Korea in 2013 as it offered higher deposit rates than local banks. The products can be bought and sold like securities, and typically have the highest debt ratings.

“The creditworthiness of deposit-backed debt is basically based on the credit ratings of the banks that offer the deposits, most of which have local AAA ratings,’’ said Kim Ji Hwan, a senior analyst in Seoul at Korea Investors Service, the local affiliate of Moody’s. “There’s never been a default on deposits-backed debt.’’

A 5.7 percent decline in the Chinese currency against the dollar since the end of 2014 has reduced investor appetite for yuan deposit-linked securities. Yuan deposits accounted for 11 percent of total underlying assets last year, down from 33 percent in 2014, while Korean won deposits made up 39 percent, followed by the U.S. dollar with 38 percent and Hong Kong dollar with 11 percent, according to KIS data.

Big Five

U.S. currency deposits accounted for the biggest share of the underlying assets from China’s top five banks -- China Construction Bank Corp., Bank of China Ltd., Bank of Communications Co., Industrial & Commercial Bank of China and Agricultural Bank of China Ltd. 

Total sales of debt linked to bank deposits including those at domestic lenders increased to 79.3 trillion won last year from 47.4 trillion won in 2014 and 16.9 trillion won in 2013, KIS data show.

“With ample liquidity in the financial markets and uncertainty over the economy, investors having nowhere to put their money are looking for a parking place for cash in the short-term,” said Kim Eun Gie, the alternative investment analyst at NH Investment & Securities Co., the nation’s largest brokerage by assets. “That’s increasing such deposits-backed debt sales.”

Yield Search

Korean investors put 112 trillion won into money-market funds as of Feb. 2, compared with 66.4 trillion won at the end of 2013. The funds invest in short-term debt and other cash-like instruments. Such funds and trust accounts at brokerages are the main buyers of deposit-linked securities, according to NH Investment’s Kim.

“Sales of products backed by deposits from Chinese banks’ overseas branches are increasing as they pay higher yields,” said Samsung Asset’s Kim, adding that those securities may have more risk. “Unlike in the past, Chinese bank deposits-backed debt offers only 10 basis points more than debt backed by local bank deposits,” making them less attractive, he said.

Before it's here, it's on the Bloomberg Terminal.