This article appeared on the 26th at 4:06 p.m. on Signal, the capital markets compass.
Credit spreads on South Korean corporate bonds have been narrowing even as high interest rates persist. Corporate bond yields have climbed to the mid-4% range, curbing new issuance, while institutional investors have stepped up carry demand for higher-rated paper. Lower-rated issues, however, are still failing to sell out, leaving investor sentiment sharply divided by credit quality.
The credit spread between three-year AA- rated corporate bonds and government bonds stood at 67.9 basis points as of the 25th, according to the Korea Financial Investment Association. That is 2.5 basis points narrower than the 70.4 basis points recorded on the 5th of this month. The gap remains more than 20 basis points wider than a year earlier, but supply and demand conditions have improved recently, driving the spread lower.
A key factor was that corporate yields rose less than government yields. The three-year government bond yield climbed 14.9 basis points to 3.826% from 3.677% between the 5th and the 25th. Over the same period, the three-year AA- corporate bond yield rose just 12.4 basis points to 4.505% from 4.381%. Market rates rose broadly on concerns about a further increase in the benchmark rate, but corporate bonds outperformed government bonds, compressing the spread.
Shrinking supply is also supporting the market. Companies burdened by high funding costs are turning to bank loans and short-term instruments such as commercial paper and electronic short-term bonds instead of public bond offerings, limiting issuance volume. For investors, meanwhile, absolute yields that have risen to the mid-4% range look attractive. Analysts expect institutional demand for two- to three-year highly rated bonds to continue as investors seek to lock in carry returns, should uncertainty over monetary policy ease.
Recent book-building results reflect that pattern. Lotte Engineering & Construction drew 151 billion won in orders for a 50 billion won offering, while KB Financial Group's hybrid securities attracted 520 billion won against a 270 billion won target. By contrast, E-Land World, rated BBB, drew only 18 billion won for a 20 billion won offering and failed to sell out. Rather than a broad recovery in sentiment, funds are concentrating on issuers with relatively strong credit quality.
Analysts say spreads have room to narrow further for some time, even once the primary market reopens after the seasonal lull. With fewer companies issuing bonds than a year earlier, sustained institutional buying would keep supply pressure modest. Still, with low-rated companies repeatedly failing to sell out their offerings, the divide between rating tiers persists, and it will likely take time for the rally to spread across the credit market.
"Credit spreads are expected to narrow as monetary policy uncertainty gradually eases and the primary market strengthens on solid demand," said Choi Sung-jong, an analyst at NH Investment & Securities. "A hold-to-maturity strategy on two- to three-year corporate bonds is valid, focused on companies in industries with favorable conditions."
