After an 18-month hiatus, LG Card, Korea's biggest credit card company, will return to the international securitization market in October with a $400 million deal via Merrill Lynch, according to sources.
In what seems a curious move, Merrill will apparently also double as the deal's sole investor. Although the bank is widely believed to have bought the $325 million MBS it arranged for Korea First Bank recently (see ASR 8/2, p.19), the quality of issuer and the underlying assets made that a low-risk investment.
Buying into a Korean credit card deal at this time, especially one from LG Card, initially had some bankers at rival houses scratching their heads. Card securitization has been a nonstarter since early 2003, when rising delinquencies set off triggers on many deals - including LG Card's.
But Merrill may actually be making a canny move, reportedly drawn to LG by the potentially rich fees, an implicit government safety net via majority shareholder Korea Development Bank (KDB) and projected tax perks, according to sources.
The Korean credit sector recently went through a rough patch. Although robust deal structures and monoline involvement on many transactions ensured timely repayment, the wider impact of credit deterioration sparked a restructuring of the entire industry. Unable to stay afloat as independent entities, most card companies were folded back into original parent or sister institutions.
As a listed entity rather than a subsidiary, LG Card, undoubtedly the hardest hit by the crisis, did not have that luxury. Nevertheless, when the going gets tough for firms in Korea, the government often comes to the rescue.
So when in January 2004 LG slipped to the brink of bankruptcy, the state-owned KDB - along with other creditors - rescued it with a W5 trillion (US$4.3 billion) package.
This came in the form of investors converting W3.5 trillion (US$3.0 billion) of debt-to-equity in the company, a process that was completed last week, as well as accepting maturity extensions on W2 trillion (US$1.7 billion) of loans. Despite this boost, LG officials say a further W1.5 trillion (US$1.3 billion) capital injection is required to avert the company being delisted in 2005.
The company's ordeal begs the question: Why would anyone invest in LG card unless they had to? Korean investors, already stuck with around US$3.6 billion existing LG Card paper, would be loathe to purchase more bonds any time soon. So why would an international bank such as Merrill Lynch?
One Merrill banker in Seoul has been quoted as saying the deal demonstrates the bank's confidence in the issuer and the strength of the Korean economy. There is some evidence that LG card, along with the other card companies, is turning things around. As news of the securitization broke, LG card shares rose 10.5%.
However, the company's percentage of overdue card bills in June was still 15.1%, while its ratio of bad debts to total debts is 11.9%. There is a long way to go before LG Card becomes stable.
Despite all this, Merrill's move could be a shrewd one, according to some competitors. In its guise as lead manager, given how no local or foreign houses have been lining up to aid LG, the bank is almost guaranteed to
be making a decent amount of fees.
Merrill's rewards for being sole investor may be even greater. Firstly, now that KDB - the government in all-but-name - is the major shareholder of LG Card, an excellent safety net exists in case the assets do not perform as expected.
Secondly, it has been suggested that investing in the deal could have major US tax benefits. This is dependent on the bank investing in the whole deal - including senior and subordinated bonds - and in the process picking up a good-sized chunk of impaired receivables on the equity piece.
For that portion, an investor would be able to write off the difference between the face value of the receivables and the current price. For example, if the receivables are purchased at 10 cents when the face value is one dollar, 90 cents can be written off on the tax return.
From a credit quality perspective, a high level of subordination means investors will not lose money and from a tax basis, they make a large profit if the impaired assets perform well. In addition, the write-off does not affect the balance sheet, just taxable income.
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