CD scandal hits Korea bonds

Korean bonds are losing popularity after a recent scandal involving possible fixing of interest rates on certificate of deposit (CD) by local commercial banks.

According to Korea Center for International Finance (KCIF) on Friday, foreign investment banks have lowered their recommendation for bonds sold by Korean banks, citing risks stemming from the local antitrust watchdog’s recent investigation into possible CD rate rigging.

Overseas banks including HSBC and JPMorgan have adjusted their investment grade on bonds issued by local banks to “neutral,” said a report by KCIF. Most of them had retained “overweight” ratings on Korean bonds since April.

The banks cited risks surrounding the recent investigation by the Fair Trade Commission into a suspected fixing of CD rates by 10 local brokerages and nine banks.

Massive fines could be levied on the financial firms and class-action suits by investors could follow.

Higher CD rates help boost local banks’ profitability as rates for many household loans are tied to CD rates.

HSBC offered a “neutral” rating on most bonds issued by Koreans except for those floated by two public firms - Korea Hydro & Nuclear Power and Korea Western Power - which had an “overweight” rating.

JPMorgan gave an “underweight” rating on foreign currency-denominated bonds sold by Korean lenders as high demand for such bonds lowered yields, curtailing investment attraction.

“Issuances of Korean bonds have been on the rise largely owing to reduced risk of the country’s credit downgrade,” said Kim Yoon-kyung, a researcher at the institution. A drop in transactions during summer vacation season could further drive down Korean bonds.

Meanwhile, the banks recommended buying credit default swaps (CDS) on debt sold by the Korean government and Korean firms as Korean bond issuers may face difficulty in raising capital in overseas markets.

The CDS premium on five-year foreign currency-denominated debt sold by the Korean government stood at 131 basis points as of Wednesday, compared with 123 basis points at the end of last month. A basis point is 0.01 percentage point.

The spread on CDS reflects the cost of insuring corporate or sovereign debts. A steep rise indicates deterioration in the credit of Korean government bonds and higher costs for bond issuances.

By Song Su-hyun, Yonhap [ssh@jooongang.co.kr]