Two upcoming cross-border CBOs coming out of Korea and mandated this year have been tainted by recent heavy losses taken on primary CBOs involving small and medium sized enterprises (SMEs).

The first offering from the US$1 billion program set up by Credit Suisse First Boston and JPMorgan Securities for the Ministry of Commerce, Industry and Energy has been put on hold.

The W300 billion ($270 million) transaction - backed by a pool of bonds issued by hi-tech companies - was due in July but the launch date kept getting moved back. Now it appears the cause of the delay has been an inability to get a third-party guarantor on board.

"The plan is to have a quasicredit guarantee fund (Korea Credit Guarantee Fund/ Korea Technology Credit Guarantee Fund) or organization like the Small and Medium Business Administration to credit enhance the deal," said a source at one of the leads. "But the involved parties have come to an agreement that this is not the right time with CBOs under heavy scrutiny."

Meanwhile, a $100 million CBO mandated to Nomura Securities and Hannuri Securities by the Korean Ministry of Finance and Economy was due in September. Despite the delay, a well-placed source insisted the deal would launch next month. The Japanese Bank of International Cooperation is supposed to be guaranteeing the deal, with the Small Business Corporation penciled in to purchase the subordinated tranche.

For Korean CBOs to sell - domestically or abroad - it is vital arrangers get a quasi-government entity to guarantee the deal. The two previous international SME CBOs from Korea, issued in late 2001, benefited from guarantees from Korea Development Bank, rated at the sovereign level of A3' by Moody's Investors Service.

In reality, investors on the $250 million Korea Credit Guarantee CBO - arranged by CSFB and backed by 51 convertible bonds - and the $344 million Koromas CBO, put together by Tong Yang Investment Bank and ADM Capital Management, were buying exposure to KDB, not the underlying SMEs.

It is a good job too, because SME performance makes for unpleasant reading. Between 2001 and 2003, government-linked guarantors extended credits to SME CBOs totaling around $2 billion. With SMEs unable to get attractive funding from banks, but the state unwilling to leave them to rot, government-sponsored primary CBOs have been a vital source of funding.

However, with the Korean economy going through a difficult 18 months, as production costs have risen and exports declined, SMEs are in a period of crisis. A report from the Bank of Korea earlier this year warned that four out every 10 small business is running a high risk of going bankrupt. The overdue debt ratio of SMEs hit 2.92% in August, up from 2.1% in December 2003.

With many domestic CBOs maturing in May, the government was able to persuade investors to give struggling SMEs more time to repay their debts. However, according to some reports, the losses amount to almost 30% of the CBOs issued. And, because many of the underlying companies are hi-tech firms - hit hardest by the economic malaise - giving them more time is not going to necessarily enhance their ability to repay their debts.

So government entities - which have enough to contend with overseeing the restructuring of failing Korean conglomerates - will now have to reach deep into their own pockets to keep CBO investors happy.

This was not anticipated when they agreed to guarantee the deals three years ago, so no wonder they are having second thoughts on doing the same in 2004. All this is bad news for SMEs and ABS bankers.

Meanwhile, activity in Japan has been quiet of late with only two transactions launched in October - both of them MBS issues by Shinsei Bank through the Hydra Trust and the Government Housing Loan Corporation, with its 24th offering.

The deals were enough to take Japanese issuance for the year past the 4 trillion ($37.7 billion) mark. MBS has been the dominant asset class in 2004, although it is unlikely there will be a glut of new issues for the remainder of the year.

First and foremost, most MBS issuers now tap the market in March and September, at the end of the fiscal year and fiscal half. Secondly, some analysts reckon investors will become more circumspect on MBS deals because of the weather.

So far this year, 10 typhoons and one earthquake have struck Japan, damaging 60,000 homes in the process. Consequently, it is believed investors expect to see future portfolios include greater insurance against these events and more geographical diversity.

Copyright 2004 Thomson Media Inc. All Rights Reserved.

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