Putting on the brakes

South Korea

South Korea’s credit cards companies have had a pretty good run. Consumer lending has been growing at an average rate of nearly 16% for each of the past five years, with the slowdown in corporate lending since the 1997/98 Asian crisis driving a stream of institutions to aggressively compete in the more profitable consumer finance business. At the same time, low interest rates have prompted a surge in credit card usage among the country’s shoppers.

Credit cards issuers have looked to manage the rapidly growing volumes of receivables through the cross-border asset-backed securities (ABS) market. Over the past two years, South Korean consumer finance-backed deals have dominated Asia’s ABS market, accounting for over half of the $5.56 billion in issuance last year. In fact, total issuance from all South Korean issuers, at $3.72 billion, accounted for two-thirds of Asia’s ABS market last year, according to a year-end report by rating agency Moody’s Investors Service.

But an explosion in credit cards delinquencies in South Korea over the past six months has led to some concern that the sharp growth in issuance may slow in 2003. According to the country’s regulator, the Financial Supervisory Service (FSS), credit card service companies recorded delinquencies (defined as one day or more overdue) of 11.7% in November 2002. This compares with 5.8% in December 2001.

As a result, the FSS introduced a series of measures last year to curb the sharp rise in delinquency rates, with stricter rules for provisioning and more rigorous definitions of default, forcing Korean credit card lenders to significantly increase their provisions for delinquent card holders. The regulator has also demanded the introduction of consumer credit review systems in an effort to cut delinquencies going forward. Nonetheless, analysts reckon delinquency rates will continue to rise in the first part of 2003, before peaking in the middle of the year and improving in the second half.

The higher loan-loss provision that banks and credit card issuers had to set aside last year has sent many firms into the red. Kookmin Credit Card Company and Korea Exchange Bank Credit Service Company – both among the country’s top five credit card firms – posted losses in 2002, partly attributing the slump to higher provisions for bad loans. LG Card, the country’s largest credit card firm, didn’t report losses for the year but saw its 2002 net profits drop by 46% from 2001, to 350.4 billion won or about $293 million.

Consequently, card issuers are now more cautious in their expansion strategies, meaning the volume of credit card receivables will likely fall in 2003, say analysts. A more conservative expansion going forward ultimately means that the lenders’ need for financing will be lower, resulting in an expected slowdown in the growth of ABS issuance. In its year end report, Moody’s states that the volume of Korean ABS backed by credit card receivables is unlikely to match the triple-digit growth seen over the past two years in 2003 – although it still estimates the Asian ABS market will reach $6 billion, with Korea still likely accounting for the majority of deals.

The rise in delinquency levels is also expected to affect the performances of existing rated transactions, with a likely deterioration in the credit quality of the collateral, at least until the new regulatory measures become more effective, Moody’s says. Nonetheless, rating agencies and market participants are quick to point out that South Korea’s poor consumer credit quality has already been priced into most existing ABS deals. “As for the rated transactions, investors are safeguarded by robust analytics, which had incorporated much of the ‘bad news,’” notes rating agency Standard & Poor’s (S&P) in a recent report on the Korean ABS market.

“International ABS transactions have sufficient credit support, stringent eligibility criteria for the designated pools and trigger events, which make the structures very strong,” agrees one Hong Kong-based securitisation specialist. Indeed, bankers say that the eligibility criteria for receivables included in the asset pool are getting stricter and the list of early amortisation event triggers – events that initiate the early repayment of the ABS issue, such as minimum repayment rate and yield triggers – are getting longer and longer on each Korean deal. A Korean issue can now have as many as 30 or 40 trigger events, say bankers.

But there are other reasons for a likely slowdown in consumer finance-backed deals in 2003. Thanks to last year’s upgrades to the sovereign and major banks’ credit ratings, the overall offshore funding availability for Korean entities has improved. Now “consumer loan companies can raise offshore funds without securitisation,” says Andy Lai, Hong Kong-based head of financial engineering at SG, a division of French bank Société Générale, adding that the bank syndicate market is one potential avenue. Raising funds through the bank syndicate market would likely cut down on marketing, rating and legal costs, particularly onerous if the ABS deal is sold publicly and includes a wrap – a payment guarantee provided by a AAA-rated monoline insurance company.

More importantly, monoline insurance companies – which so far have included a wrap on the vast majority of ABS deals to have come out of South Korea – may be close to their exposure limit to Korean issuers, say market participants. Insurers’ appetite for Korean risk is “a function of having limited capacity or credit available for Korea,” says Richard Lamb, a Tokyo-based managing director in the Asian securitisation group at Dutch bank ING. “I don’t think it’s a question of credit quality.” For instance, US-based Financial Security Assurance (FSA), one of the dominant monoline wraps on Korean deals, has been less active in the market recently, say ABS issuers. “As FSA’s capacity in the Korean market has decreased, issuers need to diversify bond insurance providers,” says one official at Samsung Capital in Seoul.

However, others note that, despite the deteriorating asset quality, monoline insurers still have appetite in Korea, even if the appetite will likely be more modest in 2003. The insurers “may be more cautious and pricing may be higher, but for the right name, there’s still appetite to do a wrap”, reckons Neil Campbell, a Hong Kong-based partner at Sidley Austin Brown & Wood, a law firm active in the Asian ABS market. For instance, MBIA and XL Capital – two monoline insurers the firm has advised in previous Korean deals – are interested in doing deals this year, he says.

But, insurers are looking more closely at the name of the issuer, says ING’s Lamb. Monoline insurers “will continue to have demand for Korean products, but they’ve become more selective”, he says.

Indeed, with market conditions expected to remain difficult, there will likely be a stratification of issuers according to perceived credit quality, with investors and monoline guarantors likely to focus on familiar issuers that have already successfully accessed the cross-border ABS market, say bankers. “As a result, issuers without a long track record will likely have to pay a premium to access the market,” says the Samsung Capital official. More generally, the official says, “spreads are anticipated to continue to come under pressure as the negative atmosphere in the global markets persists. In addition, the consumer credit issue will continue to put pressure on the market, and downgrades from the rating agencies could occur in the market”.

Rather than rely on monoline insurers to such a large degree, market participants say that transactions expected out of Korea, at least through the first half of the year, will likely be sold privately through a bank conduit – a funding facility that sponsors the cross-border ABS and issues asset-backed commercial paper (ABCP). For instance, the first deal of this year – a $300 million, five-year ABS from LG Card, was privately placed by lead manager Bank of America. The deal was also unrated and unwrapped. Going through a conduit significantly reduces market volatility and uncertainty for the issuer, as the conduit buys the ABS transaction by issuing commercial paper in order to make the ABS purchase. In other words, the transaction isn’t sold directly to investors and therefore is a lot less subject to market sentiment.

For 2003, observers say there could be more unwrapped deals sold through bank conduits and fewer public term deals. ING brought two unwrapped deals to market last year, one for Kookmin Credit Card and one for Samsung Capital. One important event that made unwrapped deals possible last year was Korea’s sovereign credit rating upgrade to the A level, allowing structured transactions to reach an AA rating.

The relative immaturity of South Korea’s ABS market meant that investors were more comfortable with guaranteed transactions, says Ben McCarthy, Hong Kong-based head of structured finance at Fitch Ratings. “[But] as the market matures and becomes more transparent, we believe this will evolve. We saw the beginning of that late in 2002 with the first unwrapped transactions”.

At the same time, “this year, the originators are beginning to question the economic value of a monoline insurance premium if they don’t see a large improvement in their overall pricing”, comments ING’s Lamb. Indeed, Korean AAA-rated wrapped deals have been seen priced between 30 basis points and 60bp over the London interbank offered rate (Libor). Kookmin Credit Card 2002–1, which was wrapped by MBIA, publicly sold and closed late last December, priced on the higher end of the range at 60bp. In comparison, Samsung Capital’s AHa auto loan deal, which was unwrapped and rated AA, and closed a few weeks before Kookmin Credit Card 2002–1, was priced at 80bp. Including the insurance premium, the chances are that Kookmin Credit Card’s all-in cost on its latest deal was higher than Samsung Capital’s AHa deal.

Nonetheless, the majority of investors are likely to favour a payment guarantee in the immediate future, particularly given the increase in credit card delinquencies. Unwrapped deals are “a natural evolution of the Korean securitisation market”, says Diane Lam, a Hong Kong-based director in S&P’s structured finance group. “But institutional investors still have heightened concerns about Korean consumer credit cards and continue to want a wrap and/or demand a higher premium.”

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