Bank of Korea: "Short-term improvement of credit bond market contraction difficult... Activation measures needed"

Credit Spreads Significantly Exceed COVID-19 Peak
Impact of Increased Issuance of Ultra-High-Grade Bonds Such as KEPCO and Bank Bonds

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[Asia Economy Reporter Seo So-jeong] The Bank of Korea forecasted that due to the ongoing uncertainty in financial markets caused by the tightening of monetary policies in major countries, it will be difficult for the contraction in the credit bond market to significantly improve in the short term. Accordingly, it suggested the need to ease market supply-demand burdens caused by increased issuance of Korea Electric Power Corporation bonds and bank bonds, and to pursue measures to enhance liquidity in the credit bond market.

In its report titled "Recent Evaluation of the Credit Bond Market Situation: Focusing on Factors Expanding Credit Spreads" on the 20th, the Bank of Korea stated, "This year, amid the rapid rise in long-term interest rates due to domestic and international monetary tightening, credit spreads have widened significantly."

The recent level of credit spreads (as of the 14th, AA- corporate bonds at 114 basis points) greatly exceeds the historical long-term average (43 basis points from 2012 to 2021) and the peak during the COVID-19 crisis (78 basis points), marking the highest level since September 2009.

Regarding the factors behind the widening credit spreads, the Bank of Korea explained, "In the rising interest rate phase, investment demand for credit bonds with low credit ratings and liquidity has sharply contracted. Additionally, supply factors such as increased issuance of ultra-high-grade bonds like Korea Electric Power Corporation bonds and bank bonds, along with the portfolio crowding-out effect among credit bonds, have contributed."

In particular, since June, when concerns about economic recession in major countries intensified, the Expected Default Frequency (EDF) for both high-grade and non-investment-grade companies has risen significantly, heightening caution toward credit risk. Furthermore, as monetary tightening accelerates in major countries, uncertainty about interest rate paths has expanded, strengthening liquidity preference and weakening incentives to invest in credit instruments with limited liquidity during market instability.

On the supply side, the total issuance volume of credit bonds has expanded significantly compared to the past, creating supply-demand pressures. From January to September this year, the net issuance of credit bonds totaled 49.8 trillion won, which is less than the 67.6 trillion won during the COVID-19 period in 2020 but greatly exceeds the long-term average of 24.8 trillion won (2012?2021).

The concentration of credit bond issuance in ultra-high-grade instruments such as special bonds and bank bonds has also caused a crowding-out effect, reducing demand for other credit bonds. The report stated, "Analyzing the factors behind the credit spread expansion up to September this year, the contribution of liquidity risk factors in the credit bond market was the largest, and the impact of increased supply of ultra-high-grade bonds like Korea Electric Power Corporation bonds and bank bonds was also considerable."

Han Min, head of the Bond Market Team at the Bank of Korea’s Financial Market Department, said, "There is a possibility that international financial market instability, like the recent turmoil in the UK financial market, could recur frequently. Supply-demand burdens also persist due to large-scale maturities of corporate bonds and bank bonds, mortgage-backed securities (MBS) from the Safe Conversion Loan program, and large-scale issuance of Korea Electric Power Corporation bonds." He added, "With rising credit caution due to market instability such as the project financing asset-backed commercial paper (PF-ABCP) market turmoil since the end of September, it will be difficult for the contraction in the credit bond market to improve in the short term."

He continued, "It is necessary to closely monitor market conditions to prevent a significant spread of instability in the credit bond market and to thoroughly prepare policy responses to stabilize the credit bond market."

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