Korean firms favor bank loans over bonds on prolonged high interest rates

[Image source: Gettyimagesbank]

Amid a prolonged period of high interest rates, South Korean businesses are increasingly turning to banks for borrowing, as they strive to meet maturing debt obligations while noticeably scaling back on the issuance of corporate bonds.

Over the span from April to the present month, the local market of corporate bonds, including asset-backed securities, has seen more corporate bonds redeemed than issued, according to market tracker Yonhap Infomax on Monday.

The progression of this trend has been substantial, with a net redemption of 84 billion won ($63.40 million) recorded in April, surging to 2.37 trillion won in both May and July. June saw a relatively modest dip, registering at 663 billion won. Notably, the trend of net redemption persisted into the current month, tallying up to 1.84 trillion won as of Friday.

This situation contrasts with the first quarter, when the bond issuance market exhibited robust activity, buoyed by the combination of low interest rates at the year’s outset and pent-up demand following the Legoland crisis in the second half of last year.

The first three months of this year all experienced net issuance with a monthly average of 4.3 trillion won.

Lending from banks increased during this period while net corporate bond redemptions continued.

According to the Bank of Korea (BOK), bank loan balances at large corporations rose by 20.3 trillion won until July this year. Monthly balance growth averaged 2.5 trillion won in the first quarter but increased to an average of 3.2 trillion won between April and July.

Analysts note that companies are turning to banks for financing rather than the corporate bond market as the high interest rate situation extends longer than expected.

The three-year government bond rate, which serves as the benchmark for corporate bond rates, has been in the 3.20-3.30 percent range for about two months from late March this year, near the yearly low of 3.11 percent on Feb. 3. However, the rate started picking up in late May and rose further in June as the U.S. Federal Reserve hinted at two more rate hikes this year.

The three-year government bond rate was 3.79 percent as of Friday.

Experts believe that the BOK is unlikely to raise the benchmark rate further from the current level of 3.50 percent, but prospects for a rate cut within the year seems unlikely, contrary to expectations at the beginning of the year. This means the current high level of interest rates is likely to continue for a longer period than expected.

“BOK Governor Rhee Chang-yong emphasized during a press conference on Thursday that financial stability takes priority over the economy and that household debt deleveraging is needed,” said Cho Yong-gu, an analyst at Shinyoung Securities Co. “This suggests that monetary policy may retain interest rates at the mid to higher range for a longer period of time, and the first rate cut may not occur until the second quarter next year.”

Normally, bank lending rates are higher than corporate bond market issuance rates. Amid a recent rise in issuance rates, however, companies appear to be looking to borrow money from banks with a one-year maturity rather than issuing two or three-year bonds at higher rates.

The move also comes in an effort to diversify funding sources.

“The corporate bond issuance market, which was strong in the first quarter, entered a lull in the second half of the quarter as credit issues emerged in the U.S. banking sector, and this state prolonged as interest rate volatility increased,” said Kim Sang-man, head of fixed income at Hana Securities Co.

This trend is likely to continue for some time.

“Global interest rates are expected to remain high for the time being, and companies may continue to favor bank loans over corporate bonds if band loan rates remain at the current level,” said Lee Kyung-rok, an analyst at Shinyoung Securities.

“September and October are generally active months for the corporate bond market, but corporate bond issuance may continue to be sluggish until the end of the year amid fading expectations for a rate cut within the year and high interest rates,” Kim said.