Kookmin Bank is readying what would be the country's first synthetic balance sheet CLO, sources report. The bank, which lists Euro-Pacific Growth Fund and ING among its major shareholders, has been working with Credit Suisse First Boston on a $700 million to $800 million, cross-border deal backed by loans extended to small and medium sized enterprises.

It is believed the proposed transaction will have a five-year maturity and a partly funded structure with dual credit default swaps on the super senior and mezzanine tranches. Sources say the structure could give Kookmin 6% to 8% regulatory capital relief on the loans.

Bankers involved in the deal are keeping quiet, but it is reported that both parties have been engaged in discussions with the Financial Supervisory Service for several weeks. If the green light were given, closing of the deal would be slated for March or April. Approval may not be a formality, however, for two reasons.

Firstly, it would be fair to say Kookmin and Korean regulators have not exactly seen eye to eye in the past. In fact, Kookmin s CEO was forced to step down by regulators in October 2004, over reported accounting irregularities'. Perhaps with a new person in charge, the relationship will improve.

Secondly, and perhaps more importantly, concerns the regulators' somewhat ambivalent attitude towards credit derivatives and synthetic securitization. Banks and insurance companies can invest in structured products, but only on a case-by-case basis subject to approval by the Bank of Korea. In addition, as credit default swaps are U.S.-dollar denominated, there may be some issue over whether the smaller companies included on a bank's loan books would be CDS quoted.

However, on the positive side, the Ministry of Finance Economy said recently it would allow local and foreign securities houses to offer structured products as early as next month, so the previous mind-set may be changing. And with Basel II requiring improved internal risk management practices - an area where many Korean banks seriously lag - the government may be keen on structured deals that enable local banks to improve competitiveness.

The timing could not be better for Korean banks to offer synthetic securitizations, according to one ABS banker in Seoul. Korean banks are generally cash rich and aim to keep their highest quality assets on balance sheet, so non-traditional ABS structures are seen improving capital efficiency.

"The government is heavily advocating banks use derivatives to better manage their balance sheets and as credit spreads in Korea are at an all-time low, the cost of doing a synthetic deal is lower than when banks have looked at this in the past," the banker says. "In a low interest rate environment when banks have high liquidity, this kind of trade allows banks to achieve all the benefits of securitization while achieving leverage/risk arbitrage benefits."

Other bankers, however, believe it is too early to think in terms of a wave of balance sheet deals by Korean banks. "For a start, they are behind their Singapore and Hong Kong counterparts in terms of capital management," comments one ABS head. "Also, there are alternative ways to reduce capital adequacy ratios, such as issuing subordinated debt and hybrid deals, which may actually be more cost effective. On the liability side, it is too early to do anything about Basel II: it would be better to wait 12 to 15 months, which suggests 2006 might be a better year."

"I think the message on Basel II is starting to hit home, and I have seen a more focused awareness by Korean banks," observed another banker. "But based on my own discussions with them, there would not appear to be many other banks thinking along the same lines as Kookmin, at least not for 2005."

While Japanese banks have actively used synthetic securitizations for balance sheet management, the rest of Asia has not really caught on, despite the advice of arrangers and rating agencies. The only two deals completed to date were the self-arranged HK$1.26 billion ($161.6 million) synthetic RMBS by the Hong Kong branch of ABN AMRO in December 2000, and a S$224 million ($137.1 million) issue by Singapore's DBS Bank in November 2001.

The DBS deal, arranged jointly by DBS Bank and JPMorgan Securities through the ALCO SPV, drew much attention and praise for the lengths taken explaining the structure and its benefits to local investors. However, the amount of regulatory capital relief achieved by DBS Bank was not made public. Rival bankers claimed the transaction cost far more than a subordinated debt offering would have for the same benefit. Subsequently, while sub-debt deals have been commonplace among Asian banks, synthetic activity has purely been arbitrage driven.

Copyright 2005 Thomson Media Inc. All Rights Reserved.

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