South Korea's determined use of securitization as a way to recover from the on-going effects of the 1997-1998 financial crisis is set to take advantage of another securitization technique: collateralized bond obligations.

The Ministry of Finance and Economy and the financial watchdog, the Financial Supervisory Service, recently announced a plan that will see many of Korea's smaller enterprises issue bonds that will be purchased by a fund set up with cash from local investment companies and banks, packaged into CBOs and sold on to local investors.

The ministry and the FSS are aiming to establish a fund worth W10 trillion ($9 billion). Of that total, at least W7 billion has been earmarked to purchase the bonds before they are parceled into CBOs, the official said, with the rest being used to buy government and municipal bonds and monetary stabilization bonds.

Investment firms, such as Daehan Investment Trust, Korea Investment Trust, Mirae Assets have agreed to put in cash, while local commercial and state-run banks held a meeting to discuss their contribution, with most of them agreeing to take part. One Korean banker said that contributions would range from W200 billion up to W1 trillion, with several banks agreeing to contribute the larger amount.

The plan comes as a response to an increasing liquidity crisis and the resulting credit crunch which has seen many of Korea's second-tier firms wobbling on the verge of bankruptcy as they have been unable to access funding. The local bond market is virtually closed to all but the strongest and most well known companies and bank lending to smaller enterprises has also dried up as banks still struggle with significant levels of non-performing loans.

Even companies that do not have credit ratings or who have below investment grade ratings will be able to benefit if the plan is a success, as half of the W7 billion will be used to buy their bonds.

The CBOs would also boast a partial guarantee (likely to be for between 10% and 30%) from local agencies, such as the Korea Credit Guarantee Fund.

A Finance Ministry official said that "dozens" of firms will issue bonds as collateral for the securities. "Because of the diversity and the guarantee, we think there will be a small chance of default and think that institutional investors will respond positively," he said.

The official added that some regulatory changes would be required to make a success of the plan. Regulations that restrict unrated or below investment grade entities from issuing certain securities will need to be scrapped, while the minimum period between a company issuing bonds and those bonds being securitized in a CBO will be reduced to two or three days from the current 15-day period.

Bankers in Seoul said that the authorities hope to repeat the success - on a much larger scale - of a recent deal in Japan which used a CLO structure to recapitalize small businesses in Tokyo (ASRI 4/10/2000 p. 8). Though that deal was only worth around $650 million and was backed by loans rather than bonds, it established that securitization can be used to direct financing to small and medium-sized Asian enterprises struggling with a credit crunch.

In that transaction, called Prestar Asset Funding and arranged by Fuji Securities, three local banks made 1,671 loans to the SMEs which were guaranteed by the credit guarantee corporation of the Tokyo municipal government. The loans were then parceled into a CLO, which was rated AA-plus by Japan Rating & Investment.

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