Wednesday, February 18, 2009

The Debts of the Lenders: South Korean Callable Bonds Trigger E. Europe Fears

Well. I called it here first! See my original post from early December:

Then compare it to this article:

and this one:

Woori Bank, a South Korean bank chose NOT to exercise its option to call in a bond ahead of its 2014 maturity. Perhaps because they don't even have the money to do so:

"Indeed, it isn't even clear that Woori would have been able to raise debt to pay off the existing notes. Many banks in Korea and throughout Asia have been shut out of the global credit market amid the credit crisis."

"Woori's announcement caused a sharp rise in the cost of protecting against defaults on its U.S. dollar bonds. Credit-default swaps covering the bank's subordinated bonds widened 0.75 percentage point to 7.75-8.75 percentage points. Swaps covering its senior bonds widened 0.15 percentage point to 5.25-6.25 percentage points."

In a system based on trust, banks paying off their callable bonds is an IMPLICIT promise that is baked into their note offerings. In this kind of market it is cheaper for the bond issuer to delay payment until maturity even though this hurts the bond holders. The immediate effects are twofold: 1) the bond issuer gets to save cash but at the expense of 2) the bond holders will demand higher premiums in the future to compensate them for the risk of such repeated actions.

The Koreans' actions in turn sparked wider fears that E. European borrowers (who are particularly strapped for cash) would also follow similar practices. The yields among E. European borrowers, which are already under pressure, soared higher. In turn, Central European banks which hold the E. European debt exposure on their books face the risk of imminent downgrade. This was not a particularly surprising development as some academics pointed out earlier in the decade:

It is unfortunate when some academics have pointed out potential trends or risks years in advance only to be ignored by the financial and/or greater academic community. Often we tend to be relegated to the "Cassandra" camp because we lack the necessary credentials (e.g. Ivy League degrees, wealthy peers, or just plain unpopular ideas) to be heard among policymakers. Instead, such academics (like myself) must be content w/proving ourselves through market actions.


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