[Click eStock] "Two Remaining Issues in the December Bond Market"

On the 17th, iM Securities forecasted in its report titled 'Two Remaining Credit Market Issues in December' that the Lotte Chemical Event of Default (EOD) issue is expected to be resolved smoothly. It also anticipated that the passage of the impeachment motion in the National Assembly would partially alleviate uncertainty, contributing to a narrowing of credit spreads.

Last week, the credit market showed weakness. Political uncertainty expanded due to the National Assembly's rejection of President Yoon's impeachment motion, and remarks related to supplementary budgets from the political sphere triggered volatility in the bond market. President Yoon delivered a public address on December 12 but made no mention of early resignation or stepping down. With political confusion continuing amid uncertainty over when a presidential replacement might occur, this acted as a negative factor for the bond market.

Meanwhile, on December 10, there was a replacement of benchmark government bonds. The yields on 3-year and 10-year government bonds fell by 5.5 basis points and 3.2 basis points, respectively, on the 10th. Asset management firms and others purchased bonds on a large scale to adjust benchmarks following the change in benchmark bonds, resulting in a market rally. However, credit bond yields did not follow the decline, causing credit spreads to widen significantly.

On December 10 alone, the 3-year AA- corporate bond spread widened by 6.3 basis points. Given the relatively lower liquidity of credit bonds compared to government bonds, it was insufficient to absorb the entire decline on the day. However, considering the volatility in spreads caused by previous benchmark changes, most spreads returned to their original levels within one to two weeks. The credit spread widening caused by this benchmark change is also expected to be a temporary reversal. Nonetheless, due to political turmoil and book closing periods leading to a quiet secondary market, it is judged that more time will be needed before spreads return to previous levels.

The Lotte Chemical EOD issue is expected to be resolved smoothly. A bondholders' meeting due to the occurrence of the Lotte Chemical EOD event is scheduled for the 19th. For reference, the special covenant clause triggering the Lotte Chemical EOD issue requires maintaining an EBITDA (earnings before interest, taxes, depreciation, and amortization) of at least five times the average interest expense over three years. However, as of the end of September this year, the EBITDA to interest expense ratio was 4.3 times, triggering the EOD event.

To resolve this, on the 13th, Lotte Group signed contracts with four commercial banks to provide credit enhancement for Lotte Chemical's corporate bonds. Lotte offered the Lotte Tower, valued at approximately 6 trillion KRW, as collateral. The credit enhancement amount is about 2.5 trillion KRW. With principal and interest guaranteed by the commercial banks, Lotte Chemical bonds have effectively become bonds with no risk of non-payment.

It is judged that Lotte will propose two main directions for adjusting the special covenants at the upcoming bondholders' meeting. The first is to maintain the existing covenants but allow a grace period to restore compliance. The second is to delete the covenants altogether. Researchers Kim Myung-sil and Lee Seung-jae stated, "Considering the current sluggish business conditions in the petrochemical sector, Lotte Group seems to be leaning toward deleting the covenants themselves," adding, "Ultimately, with principal and interest guaranteed, it will be difficult for bondholders to exercise veto rights." If the financial covenant adjustment succeeds on the 19th, the liquidity crisis rumors surrounding Lotte Group are expected to subside, and the credit market will likely stabilize.

The passage of the impeachment motion in the National Assembly is expected to partially resolve uncertainty and contribute to a narrowing of credit spreads. On the 14th, the second impeachment motion against President Yoon passed the National Assembly plenary session with 204 votes in favor. As a result, President Yoon's duties were suspended, and after a maximum 180-day review, the Constitutional Court will make the final ruling on the impeachment. Previously, various proposals aimed at resolving political instability, such as early resignation or voluntary stepping down, were raised in the political arena but failed to eliminate ultimate political uncertainty. However, with the passage of this impeachment motion, some political uncertainty has been alleviated, allowing financial markets to stabilize. Researchers Kim Myung-sil and Lee Seung-jae noted, "Looking at the credit market trends during former President Park Geun-hye's impeachment, credit spreads narrowed following the passage of the impeachment motion in the National Assembly," and added, "Similarly, this time, the resolution of uncertainty will lead to financial market stabilization and increased pressure to narrow credit spreads."

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