Prospects for standalone covered bond issuance from South Korean banks have improved following the establishment of covered bond guidelines by the country’s regulators, a move announced yesterday (Wednesday). KHFC is meanwhile preparing a second pooled, international issue after launching the country’s first domestic covered bond.

The Financial Services Commission (FSC) and Financial Supervisory Service (FSS) described the guidelines as part of measures to implement “Comprehensive Measures on Household Debt”, which were also released yesterday.

“The guidelines are intended to provide a framework for covered bond issuances, diversifying banks’ financing instruments and encouraging banks to offer more long term and fixed rate mortgage loans instead of short term and floating rate ones,” said the FSC and the FSS.

Their statement refers to “key contents”, including a covered bond definition, cover pool eligibility, minimum overcollateralisation and an issuance cap, but it is not clear if these are intended to represent the guidelines in their entirety. A spokesperson from the FSC had not responded to questions from The Covered Bond Report by the time of going to press.

The statement said that covered bonds are effective funding tools that banks can use even in times of crisis.

“Also, covered bonds will enable banks to raise funds at a lower cost with long term maturities so that they can afford to offer more long term and fixed rate loans,” it added.

Jerome Cheng, vice president, senior credit officer at Moody’s, told The Covered Bond Report that the establishment of a covered bond framework has been under discussion for quite some time.

“Market participants have been lobbying government to enact a law or publish guidelines,” he said. “From market participants’ perspective, having guidelines will allow originators to structure covered bonds with a higher degree of certainty.

“The guidelines, which we have not yet assessed, should give additional comfort to investors.”

In the absence of a covered bond framework only one Korean bank has issued a covered bond on a standalone basis – Kookmin Bank, with a $1bn issue in 2009. Korea Housing Finance Corporation (KHFC) has issued a covered bond, but this was under an act governing the institution and the bond is backed by pooled collateral from its member banks (see below for more).

The FSS is today (Thursday) sending a “notification of the guidelines” to the Korea Federation of Banks and commercial banks, it said.

“After monitoring the issuances of covered bonds in the future, we will have further discussions on whether to come up with legally binding regulations on covered bond issuances,” it said.

All on board second KHFC issue

Korea Housing Finance Corporation is preparing a second cross-border benchmark covered bond after having recently sold the first domestic issue.

The transaction will be launched under an act governing the institution and will be backed by a dynamic pool of so-called Bogeumjari loans from all of KHFC’s member banks.

The covered bonds have been assigned a provisional Aa3 rating by Moody’s, taking into account factors such as an A1 issuer rating, the credit quality of the cover pool as reflected in a collateral risk score of 6.1%, and minimum committed overcollateralisation of 18%, according to a Moody’s pre-sale report from 22 June.

Joe Wong, assistant vice president, analyst at Moody’s, highlighted the dual recourse nature, good quality cover pool and swap agreements as important features of the KHFC structure.

The report describes Bogeumjari loans as loans developed by KHFC to promote the welfare of moderate and low income households. They have maturities of 10-30 years and are either long term fixed rate mortgage loans or long term hybrid adjustable rate mortgage loans.

The initial cover pool is solely comprised of the latter (Keumi Seolge Bogeumjari loans), with a low weighted average loan-to-value of 51.9%. In addition, Moody’s highlighted as positives that all the mortgages are first ranking, full documentation loans and secured by apartments, the market for which is more liquid than other types of residential properties in Korea.

Moody’s highlighted as a negative characteristic of the cover pool that it initially solely comprises hybrid loans with interest-only periods before they start amortising on a monthly basis.

In contrast to KHFC’s first covered bond, a $500m five year issue that was launched in July 2010, this transaction will be backed by an initial pool comprising loans from all seven of KHFC’s member banks. The first issue was backed by mortgages from three member banks, and is trading at around 160bp over mid, according to a covered bond banker. The forthcoming transaction is expected to come with a five year maturity.

Moody’s has assigned a Timely Payment Indicator (TPI) of “improbable” to the covered bonds.