A total of nine cross-border transactions emerged from Korea in 2002, with a total issuance size of US$2.9 billion, according to Standard & Poor's. S&P has rated a total of US$3.6 billion Korean card securitizations, the majority of which have benefited from a triple-A monoline wrap. Nonetheless, the Korean securitization market - the second largest in Asia - is presently undergoing some turbulent times.

Concerns have arisen regarding the Korean consumer credit sector, especially the credit card sector, with commercial banks and card companies reporting substantial charge-offs. The combination of these charge-offs and a surge in restructuring activities has resulted in a liquidity crunch for the sector.

S&P reported that high levels of delinquencies are expected to persist for some time, creating a drag on corporate profits, eroding net worth and ultimately increasing the cost of funding. This, coupled with geopolitical instability and the unearthing of accounting problems at SK Global in March, led to greater investor concern, and buysiders consequently began to pull out of the Korean bond market.

This liquidity crunch comes at a time when approximately W2.5 trillion (US$2.08 billion) of domestic card ABS will mature over the next three months, with approximately W3.7 trillion (US$3.08 billion) coming due over the full calendar year of 2003.

However, the South Korean government has announced a series of measures addressing the problems facing the sector. Under the new measures, banks, brokerages and insurance companies will set aside W5 trillion (US$4.17 billion) in loans to buy bonds issued by credit card funds. According to S&P, these funds will be used to purchase around half of the estimated W10.4 trillion (US$8.67 billion) in card company bonds owned by investment trust firms falling due between April and June.

In addition, card companies will be required to improve their balance sheets by replenishing capital by approximately W4.6 trillion (US$3.83 billion), instead of the W2 trillion (US$1.67 billion) as was previously planned. Lastly, Korea Asset Management Corp (KAMCO) will buy more than W4 trillion (US$3.33 billion) in bad loans held by local credit card companies. However, as one market participant explained, this should not be seen as a sign of a government bailout because KAMCO will effectively be buying the loans at commercial rates.

Current

performance

The household sector debt in Korea has increased rapidly since 1999. The one-day card delinquency ratio for the nine independent credit card companies rose sharply to 11.1% at the end of December 2002 from 5.8% in the previous year. Over the same period, delinquencies for the 16 card businesses operated by banks or their subsidiaries and affiliates rose from 7.4% to 11.8%. (See Chart 1).

A series of measures taken by the Korean government, however, dampened the rise in consumer credit - particularly in the card sector. S&P says that the rapid rise in delinquent card loans can be attributed to a confluence of factors. During 2001, there was a government exercise to curb the growth of the card companies and to better manage their portfolios. In addition, increased attention on servicing and the overall borrower's exposure revealed weak credit quality of the card loan receivables.

S&P's April 3 article, Korean Structured Finance Bonds Hold Up Well in Turbulent Times, states that all card securitization deals rated by S&P have been examined, and although delinquencies have been on the rise - especially in 2003 - the ratio of loans that are 31 to 60 days in arrears remains relatively low. The agency added that rated deals are performing well due to strict obligor selection criteria and the incorporation of credit enhancements appropriately sized to protect against the weakening credit environment.

Surveillance data, according to S&P, also shows that securitized card receivables (based on composite numbers) have not experienced more than a 9% rate of delinquencies past due one to 30 days, and less than 2% for delinquencies past due 31 to 60 days. This compares favorably with industry averages.

"Since we have published our report in April 2003, the situation has worsened quickly," said Diane Lam, director in the structured finance group at S&P. "We are seeing a sharp rise in the delinquency and restructuring levels, and in some cases the numbers are very high." She added that the agency is also seeing higher levels of restructuring accounts (which are deemed defaults) and restructuring activities taking place for accounts in early stages of delinquency such as 30 to 60 days overdue in some cases.

She also says that S&P is closely monitoring all card deals - as are other interested parties such as monolines and conduits - in light of the difficulties facing the Korean card industry and the performance of the securitized portfolios.

However, Lam added, "Investors of wrapped deals can look always to the monoline for timely payment and full principal by final legal maturity in the event such needs should arise."

Alexander Batchvarov, managing director and head of international structured finance research at Merrill Lynch, wrote in the May 15, 2002 International Structured Credit Weekly that, "In terms of long term reliability of the monoline insurance, we maintain our view that the main risk to investors is the extension risk related to principal repayment of the transaction by the monoline (in case it needs to make such a repayment) at the later of scheduled amortization, expected maturity or legal final. The difference between the latter two is between one and two years depending on the deal type."

Lam points out, however, that, "The card transactions also have some built-in liquidity feature," adding that "The card transactions are structured with protective mechanism such as trigger events, which if breached and not temporarily waived, cured or had covenants amended, could result in an early amortization of the transaction. A structured deal entering early amortization is actually a protective feature which benefits the investors and reduces their exposure when the credit quality turns suddenly."

Batchvarov added that the performance deterioration of Korean consumer securitization is within their initial expectations and - as far as they can tell - has been factored into the agency's assumptions when sizing credit enhancement and deals' structural features.

"On a recent visit to Korea the credit card companies have warned us that the numbers will get worse before they get better," Lam added, "especially as they are at present going through a process of restructuring and weaning out the weaker credits in the portfolios. However, at this point in time, it's still too premature to say that the consumer credit situation is getting better."

Lam also notes that it is increasingly difficult for the card companies to restructure weaker borrowers in their portfolios because other lenders are also doing so at the same time, thereby placing increased pressure on the marginal borrowers.

Further, as Lam explains, "For the general portfolio of the card companies, it is also the case that the level of losses will show an increase for some time because the credit card companies are not growing their loan portfolios and the arrears ratio will therefore continue to be high."

Future direction

for ABS

S&P's Lam expects the cross-border market to be fairly tame this year in terms of issuance. "There is one credit card transaction which is live' that is being worked on for a subsidiary of Samsung Capital," she added, "and a few RMBS transactions could also come to market by year-end. But compared to last year, the activity level in Korea for cross-border deals is quiet.

"We are expecting the market to pick up somewhat," she noted, "If the delinquencies in the portfolios come under control and we enter a more manageable situation, then there could be the possibility for more deals to come to market."

In the domestic market, it seems that activity will also be somewhat quiet compared with the strong issuance levels experienced last year. Lam adds, "Even the domestic ABS Korean market in April and May was very jittery; it was affected by the SK scandal, and was feeling the effects of the North Korean tension and Iraq war, which caused the South Korean domestic markets to retrench during that period." However, she said that there are signs right now that the domestic markets are opening up again with deals coming to market.

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