Hanil, Government, and KDB Establish 10 Trillion SPV... "Also Purchasing 'Fallen Angel' Limited BB-Rated Corporate Bonds"

Bank of Korea Establishes Direct Loan SPV
Hong Nam-ki "Scale Up to 20 Trillion Won if Necessary"

[Asia Economy Reporters Eunbyeol Kim, Sehee Jang] The Bank of Korea, the Korea Development Bank, and the government have decided to establish an entity to purchase non-investment grade corporate bonds and commercial papers (CP) in response to financial market instability caused by the novel coronavirus disease (COVID-19). The total scale is 10 trillion won, and it will be operated as a 'direct loan' method where the Bank of Korea, the Korea Development Bank, and the government provide funds to a special purpose vehicle (SPV). The government and the Korea Development Bank will each contribute 1 trillion won, while the Bank of Korea will bear 8 trillion won.

On the 20th, officials from the government and the Bank of Korea stated, "Although conditions in the corporate bond market have somewhat improved since mid-April, the market for non-investment grade bonds rated A or below remains sluggish, and credit risk aversion in the funding market persists," adding, "We will concretize the establishment of a corporate bond and CP purchase entity including low credit ratings to actively resolve instability factors in the bond market."

The issuance amount of corporate bonds rated A or below decreased from 1.3 trillion won in February to 1.2 trillion won in March, and further down to 200 billion won last month. The proportion of corporate bonds with maturities under three years also increased to 19.9% in March and 21.5% last month.

Initially, the government announced plans on the 22nd of last month to establish an SPV worth 20 trillion won. However, as the market has somewhat stabilized recently, it was decided to first operate the SPV at a scale of 10 trillion won while monitoring the situation. The Bank of Korea will bear 8 trillion won in senior loans, and the Korea Development Bank will provide 1 trillion won in subordinated loans using funds raised through industrial finance bonds. The government will contribute 1 trillion won by adding 500 billion won from the 2021 budget and 500 billion won from the third supplementary budget.

Deputy Prime Minister and Minister of Economy and Finance Hong Nam-ki said in his opening remarks at the 4th Emergency Economic Central Countermeasures Headquarters meeting that "the SPV will be operated temporarily for six months, and the extension will be decided based on market stability," adding, "If necessary, the scale will be expanded up to 20 trillion won."

With the government and the Korea Development Bank contributing a total of 2 trillion won, the Bank of Korea will secure 10% credit enhancement of the SPV. In case of losses from corporate bonds purchased by the SPV, losses will first be deducted from the government's capital contribution. If the 1 trillion won is fully exhausted, losses will then be deducted from the Korea Development Bank's subordinated loan funds. The U.S. Federal Reserve (Fed) also provided a 10% payment guarantee from the Treasury for its SPV purchasing corporate bonds.

An official from the Bank of Korea explained, "We decided to establish the SPV through direct loans because we believe the Bank of Korea's commitment to financial stability will be more clearly conveyed to the market, which will have a significant effect," adding, "The sufficient credit enhancement through the government and the Korea Development Bank is also a reason for direct loans by the SPV." The Bank of Korea has stated that a payment guarantee of about 10-20% is necessary for direct loans to minimize losses.

The lower limit for corporate bond grades purchased by the SPV is, in principle, BBB, which is the lower limit of investment-grade corporate bonds. A Bank of Korea official said, "We will mainly purchase high-quality and A-grade corporate bonds, but will also purchase bonds rated BBB or below," adding, "We will also purchase so-called 'fallen angel' corporate bonds, which have fallen from investment grade to speculative grade due to the COVID-19 shock, in emergencies." For CP and short-term bonds, grades A1 to A3 will be purchased.

However, companies that have recorded an interest coverage ratio below 100% for two consecutive years will be excluded from purchase targets. This means support will be provided only to companies temporarily facing funding difficulties due to the COVID-19 situation, and the SPV is not intended to prolong the life of zombie companies. Also, only corporate bonds and CPs with maturities within three years will be purchased. A Bank of Korea official said, "This is a temporary liquidity supply in times of crisis."

To prevent support from concentrating on specific companies or industries, purchase limits have been set. The purchase limit for the same company or corporate group is set within 2-3% of the total SPV support amount. The SPV purchase interest rate will be the market rate plus an additional fee. The additional fee will be differentiated by credit rating (higher fees for lower credit ratings) but will be capped at 100 basis points (1 bp = 0.01 percentage points).

The government expects the SPV to be effective in stabilizing the bond market as the Bank of Korea and the Korea Development Bank actively participate in its establishment. A government official explained, "The roles among the government, central bank, and policy financial institutions have been divided," adding, "However, considering the high risk of low credit rating corporate bonds, the purchase of BB-rated corporate bonds will be limited to fallen angel corporate bonds."

The market also welcomes the move. Gong Dong-rak, an economist at Daishin Securities, said, "Just confirming that there is a central bank that can support from behind in times of crisis will have a considerable effect," adding, "This is a very proactive measure by the Bank of Korea." However, there are also opinions that the purchase targets should be expanded further for greater effect. Professor Sangbong Kim of Hansung University’s Department of Economics stated, "It is meaningful that the central bank is directly purchasing corporate bonds, but currently BBB investment-grade bonds are trading well in the market, so the problem lies with BB and B-rated corporate bonds."

This content was produced with the assistance of AI translation services.