If Korean Tensions Flare Again, South's Bonds Seen as a Buy

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(Bloomberg) -- Summits in coming weeks aimed at denuclearizing the Korean peninsula could stumble, and any renewed strains would push down the value of offshore bonds from the South’s companies to more attractive levels, one debt investor says.

Any flareup in tensions with North Korea would be a “repricing catalyst” so long as there is no actual fighting, according to Hyun Kim, the emerging market corporate bond portfolio manager at Union Investment in Frankfurt. The notes are usually “rather expensive” because of strong fundamentals, he said.

Take Hyundai Capital Services’ 3 percent U.S. currency debt. The yield premium on the notes surged to as high as 145 basis points over sovereign bonds in September last year as North Korea tested what it called a hydrogen bomb. The spread has come down to 126 as U.S. President Donald Trump said he expects to meet North Korean leader Kim Jong Un in May or early June.

“You have to be in the camp believing that there is going to be escalation, however, no military conflict in the end of course, to be a buyer of Korean credits,” said Kim, whose firm managed 324 billion euros ($401 billion) of assets as of December 2017.

South Korea President Moon Jae-in, who is set to meet Kim Jong Un next week, said he expected a “big step” toward denuclearization during the proposed summit between Trump and the North Korean leader. Trump is laying the groundwork for the meeting, including an unannounced trip to Pyongyang a few weeks ago by CIA Director Mike Pompeo. Union’s Kim said “the potential for negative surprise” out of the meeting may be bigger than the market expects.

Korean U.S. dollar bonds have historically been expensive in Asia relative to their counterparts and have been quite stable despite geopolitical risks, according to Alan Low, credit research analyst for Asia fixed income at Aberdeen Standard Investments.

While “continued de-escalation of tension with North Korea would be a booster to investor sentiment,” the impact on dollar notes may be limited due to their tight valuations, said Low. He added that his firm is open to adding positions in the debt if the opportunity arises.

Union’s Kim, who is a German national whose parents immigrated from South Korea in the 1970s, said he’s quite familiar with the situation on the Korean peninsula.

“I am probably less worried than the average person in Western Europe about, for example, a military conflict between North Korea and South Korea,” he said. Kim said he’s “probably similar to the average citizen in South Korea, a country that had to deal with this situation for 60-plus years.”

See also: Korean bond sales hit a record as the economy booms

Kim said the recent drop in South Korea’s sovereign bond risk suggests the market has priced in a lot of the positive developments on the peninsula. Credit-default swaps insuring the nation’s debt have dropped 29 basis points from a 19-month high reached in September to 47 basis points, and have been lower than China’s contracts since January, CMA data show.

Korean offshore bonds are usually too expensive to hold in big amounts in emerging market debt portfolios, Kim said. The nation has the third-highest credit rating from Moody’s Investors Service and S&P Global Ratings, and its economy remains on track to grow 3 percent this year, driven by exports.

Borrowers in the pipeline to sell dollar securities include Doosan Heavy Industries & Construction Co., KDB Life Insurance Co. and airline companies, according to people familiar with the matter, who aren’t authorized to speak publicly and asked not to be identified.

For the Korean notes, “any repricing making them cheaper is normally a welcome development, obviously for investors and not so much the issuers,” Kim said.

©2018 Bloomberg L.P.

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