Issuer: Korea Development Bank
Amount: $300 million
Issue type: Floating rate note
Launched: June 16
Lead manager: Goldman Sachs
Great things often come from small things. Such was the case last month when Korea Development Bank (KDB) issued an innovative $300 million floating rate note that grew out of a small MTN. The bonds offered investors the equivalent of disaster insurance should Korea's premier borrower, and Euromoney's recently nominated best Asian borrower, get downgraded.
The five-year bonds can be redeemed early if the borrower is downgraded below A3 by Moody's or below A- by Standard & Poor's. The borrower is currently rated A1/ AA-, the equivalent of the South Korean government. Credit has become a key issue for Korean borrowers following the collapse of the Hanbo conglomerate in January. This was particularly detrimental to the banking sector which did not emerge from the scandal with an image that suggested prudent lending. In addition, foreign investors have been concerned by the slowdown in economic growth, falling export orders and worries about the country's competitiveness.
While KDB has continued to access the international markets in recent months with the likes of an inflation-linked yankee, and a Korean debut in the sterling floater market, it has become increasingly aware of growing investor worries about its credit.
Partly this is because it is perceived to be a barometer of Korea Inc's own economic performance. The state-owned bank's primary purpose is described in the KDB Act as to "furnish and administer funds for the financing of major industrial projects in order to expedite industrial development and expansion of the national economy."
Its spreads have widened as a consequence of investor jitters. For example, its 10-year global traded in the mid-50s at the beginning of the year. Post-Hanbo it has jumped out to 86 basis points over treasuries.
So DS Kim was keen to hear any ideas that could save him basis points and allow him to march toward the completion of an even more ambitious funding programme this year than last. The general manager of the KDB's international finance department was given just such an idea when Goldman Sachs' head of MTNs, Jonathan Gittos, relayed a large European investor's idea for a private placement to Carlos Cordero, Goldman's fixed income supremo in Asia. It was a classic case of reverse enquiry Goldman is not one of KDB's MTN dealers, although it has recently done modest MTNs for the borrower in US dollars and Swiss francs.
A large "real money account", as Gittos puts it, got on to Goldman on Wednesday afternoon (London time) wanting some Korean exposure with limited credit downgrade risk. The original private placement was to be in the order of $75 million.
Kim, who has been with the KDB since 1970, first heard the idea on the evening of Thursday June 12. From then on events moved quickly. A conference call followed on Friday which discussed whether a larger, public deal might be possible based on the same idea. Goldman, which had done a put bond in the past for fellow Korean borrower, Kepco, described 19 variations on the put bond structure.
The call, which lasted about half an hour, hooked up London, Hong Kong and Goldman's man-on-the-ground in Seoul, Tommy Oh, with the KDB team. It produced a wide number of ideas from Kim regarding his objectives. Primary among them was a desire to attract new investors who had never bought Korean paper. He also wanted the put option to remain "so unlikely a scenario that KDB could live with it". In addition he wanted to be able to restructure the deal sometime in the future, should Korean spreads radically improve.
Goldman responded in a second conference call later that day by trying to turn Kim's objectives into a workable structure, having spent the intervening hours sounding out European investors. It suggested a five-year bond, with a minimum size of $300 million and incorporating the afore-mentioned put structure, which Goldman called a "soft put". A call option was also embedded so that after three years KDB could refinance the bond should its spreads improve.
Kim replied that this was exactly what he wanted, and to the great relief of the Goldman contingent he said it would be carried out as a sole mandate once his board had granted its approvals.
Normally on public deals the KDB will take around a week to secure such approvals. On this occasion Kim went to the bank's board on Saturday morning and gave it a number of options.
Obviously Kim and his team had heard a large number of suggestions in the preceding weeks. Where FRNs were concerned, says Kim, "we received proposals where prices were based on the secondary market performance of our globals. But we did not feel that was an appropriate way of pricing. Some of them said our all-in-cost would be 28bp over Libor to 32bp over." In the event KDB was able to achieve a cost of funds equivalent to 20bp over, which suggests investors paid a 10bp "comfort" premium for the Goldman structure.
Kim explained to the board exactly how the put structure worked, and ended by recommending it as the best funding option at the time. The nod was given and Goldman was formally mandated.
The issue was launched on Monday amid great interest. Kim was very pleased with the result. "We cannot expect such a fall in our rating to happen," he says. "But it is good to give investors an instrument that gives them comfort that our credit rating will continue to be strong in the future. We are sending out the message that KDB will continue to be 100% government owned. We will not be privatized. We will continue to be sovereign risk." Some investors came on board later in the week, partly because they had to go through a raft of approvals, never having bought Korean debt before. But the deal was mostly sold by the end of the week.
The deal marks the apex of the KDB's recent strategic changes. A bit like the World Bank it is moving from large globals to smaller more innovative deals, often in a wide range of currencies. This year alone it has issued Pta10 billion and L100 billion deals. And in spite of the Hanbo difficulties it has already raised $3 billion in public and private deals since January, against its original target of $4 billion for the year to December.