Establishment of SPV Buying 'Speculative Grade' Corporate Bonds... "Launch After 3rd Supplementary Budget Passed" (Comprehensive)

Bank of Korea Direct Loan Method... 10 Trillion Scale
Hong Nam-ki "SPV Size to Expand up to 20 Trillion if Needed"

Government and KDB 2 Trillion, BOK 8 Trillion Burden
Launch After 3rd Supplementary Budget Passes National Assembly

[Asia Economy Reporters Eunbyeol Kim and 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, structured as a 'direct loan' method where the Bank of Korea, Korea Development Bank, and the government provide funds to a special purpose vehicle (SPV). The government and Korea Development Bank will each contribute 1 trillion won, while the Bank of Korea will cover 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.

◆ Launching with a 10 trillion won scale... "Expandable to 20 trillion won if necessary" = Initially, the government announced on the 22nd of last month plans to establish an SPV with a scale of 20 trillion won. However, as the market has somewhat stabilized recently, it was decided to operate the SPV initially at 10 trillion won while monitoring the situation and allowing for scale expansion if needed. 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, combining 500 billion won from the 2021 budget and an additional 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, "The SPV will be operated temporarily for six months, after which the extension will be considered based on market stability," adding, "If necessary, the scale will be expanded up to 20 trillion won."

With the government and 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 full 1 trillion won is exhausted, losses will then be deducted from the Korea Development Bank's subordinated loan funds. Similarly, the U.S. Federal Reserve 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, resulting in greater effectiveness," adding, "The sufficient credit enhancement through the government and 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.

◆ Purchasing speculative-grade corporate bonds (BB) that declined due to COVID-19 shock = The lower limit for corporate bond grades purchased by the SPV is, in principle, BBB, which is the lower limit for investment-grade corporate bonds. A Bank of Korea official said, "We will mainly purchase high-quality and A-rated corporate bonds, but will also purchase bonds rated BBB or below," adding, "We will also purchase so-called 'fallen angels'?corporate bonds downgraded 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 with an interest coverage ratio below 100% for two consecutive years will be excluded from purchase. This means support will be provided only to companies temporarily facing funding difficulties due to the COVID-19 crisis, and the SPV is not intended to prolong the life of zombie companies. Additionally, 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 concentration of support 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 capped at a maximum of 100 basis points (1 bp = 0.01 percentage points).

◆ "Bank of Korea's proactive move welcomed by the market... actual launch after passage of the third supplementary budget" = The government expects the establishment of the SPV by the Bank of Korea, Korea Development Bank, and others to be effective in stabilizing the bond market. A government official said, "Roles will be divided among the government, central bank, and policy financial institutions," adding, "However, considering the high risk of low credit rating corporate bonds, BB-rated corporate bonds will be purchased only for fallen angel bonds."

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

[Image source=Yonhap News]

The actual launch of the SPV will occur after the third supplementary budget bill passes the National Assembly. This is because half of the government's 1 trillion won capital contribution to the SPV is included in the third supplementary budget. The government and the Bank of Korea stated, "Of the government's 1 trillion won capital contribution to the Korea Development Bank, 500 billion won is included in the third supplementary budget," adding, "After the supplementary budget passes the National Assembly, the Korea Development Bank will contribute 1 trillion won to the SPV based on the government's capital contribution, launching the purchase entity." The Bank of Korea and Korea Development Bank plan to execute loans of 8 trillion won (senior) and 1 trillion won (subordinated), respectively, in line with the SPV's corporate bond and CP purchase scale.

Since there will be a gap until the SPV actually launches, the government and the Bank of Korea said, "We plan to minimize policy gaps through pre-purchase of bonds." Depending on market conditions, the Korea Development Bank may purchase low credit rating corporate bonds and CPs first if necessary.

The Bank of Korea can directly lend to the SPV based on Article 80 of the Bank of Korea Act (Loans to For-Profit Enterprises). If credit provision by financial institutions is significantly contracted or if there is a high likelihood of serious difficulties in funding from financial institutions, the Monetary Policy Committee may approve loans to for-profit enterprises with the consent of at least four members. Since the SPV launch will occur after the third supplementary budget passes the National Assembly, the Monetary Policy Committee will handle this matter when the Bank of Korea actually executes loans to the SPV after its launch.

The funding support method will be a capital call system, where loans are provided when the SPV requests funds. If the SPV's operating scale shrinks due to early repayment by companies or market normalization, the SPV will prioritize repaying the Bank of Korea's senior loans first.

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