Bankers and traders went on a white-knuckle ride in South Korea last month. But this time North Korea and the war in Iraq couldn’t take all the blame.
The country was rocked by an accounting scandal. SK Global, the trading arm of the SK Group, the country’s third-largest chaebol (conglomerate) was accused of inflating profits by W1.56 trillion ($1.2 billion) and hiding bank obligations of W1.1 trillion. SK Group’s chairman, Son Kil Seung, and 10 other executives were indicted. The Kospi index dropped to a 17-month low, making it the region’s worst-performing bourse over the year and bond spreads blew out by between 50 and 80 basis points.
Then, just as the markets attempted to claw back losses, two other corporates came under scrutiny. Hyundai Merchant Marine was accused of massaging numbers and trying to hide W300 billion of loans from Korea Development Bank. And the Financial Supervisory Service is investigating allegations of inflated profits at the Hanwha Group. In addition the chairman of Posco, the country’s largest steel producer, resigned. Yoo Sang-Boo is to face charges because of alleged share manipulation and spending W800 million of company money to buy and furnish a luxury flat for himself.
Although the sums pale into insignificance compared with Daewoo’s financial scandal – it inflated its assets by $30 billion, leading to its eventual collapse in 1999 – the cases still spooked international investors. And many are concerned that the most recent uncovering of skewed numbers could be the first of many if the new government lives up to its election manifesto promises. Prime minister, Roh Moo-Hyun, pledged to get tough on corporate malpractice and corporate governance abuses, which would mean tackling the all-powerful chaebols head on.
Many see this as a necessity but others fear if the government is too aggressive too soon it might open a catering-size can of worms. “To the credit of the government it shows it is very serious about transparency,” says Dominique Dwor-Frecaut, a credit analyst at Barclays Capital. “But on the other hand you have Iraq and North Korea. So perhaps its timing could have been better.”
Mass exodus
But observers credit the government for its handling of the fallout. They point out that it was quick to reassure investors and took active measures. When the SK Global story emerged it prompted a mass exodus from the company’s bonds and any other companies associated with it. Spreads blew out and talk of a credit crunch spread.
But the administration took action. It injected $1.6 billion of emergency funds into investment trust companies as money flooded out. In addition, as credit card companies’ debt suddenly became very unattractive to bond investors – spreads widened by as much as 250bp in some cases – Korea Asset Management Company said it would buy half of the W11 trillion of bad loans held by credit card companies.
With those companies having to issue over W26 trillion in debt this year and many suggesting that without government intervention they would be shut out of the market, it couldn’t have come at a better time.
“The government has plenty of experience managing a crisis,” says one analyst. “Also when it says it will buy the bad debt from credit card companies they will make sure they implement rigid restructuring plans that will limit the threat of moral hazard.”
Others were also caught in the fallout. Government-owned banks, which the government is trying to privatize, saw their limited number of listed shares tumble in value. Cho Hung Bank fell 27%. Such a slump puts the government in a difficult situation. Does it try to recoup the $128 billion it pumped into the financial sector during the Asia crisis as soon as possible? Or should it further delay selling and hope shares rise?
Other corporates away from the financial sector had their plans affected too. Korea Highway Corporation cancelled its $300 million bond offering as the market went Korea-risk-sensitive. The sovereign soon followed, postponing its plan to sell $1 billion. It was an understandable reaction given that South Korea’s 08s are 165bp over US treasuries, or 50bp up on the start of the year.
Despite all the negatives Dwor-Frecaut remains optimistic. “Things are pretty dire now but they are on the mend,” she says. “And while they get better and implement more acceptable levels of corporate governance they have the macroeconomic resilience to make up for microeconomic weaknesses.” It’s something that could not have been said three or four years ago but South Korea has made and continues to make significant steps in the right direction.
