Concerns about Serious Disturbance in the Bond Market

There is a warning for the first half of next year that there will be a serious disturbance in the bond market when the maturity of bonds worth 3.16 trillion won comes, because of issuance and transaction of high risk corporate bonds.

If a company goes bankrupt when bonds mature, there could be a “domino effect,” in which other corporate bonds could suddenly drop because the demands of fund withdrawal from the fund portfolio which invest in the corporate bonds.

In this case, the financial market would become paralyzed temporarily as in the 1999 incident of Daewoo bonds and the 2003 credit card bonds crisis. As a result, bond investors and corporations would suffer.

On December 10, according to KIS Pricing Incorporation and the Korea Securities Computer Corporation, the transaction of BBB corporate bonds by small investors including individuals and mutual saving banks increased to 6.8284 trillion won, which is 2.9 times greater than last year (2.3687 trillion won).

It is the first time since Korea’s foreign currency crisis that the amount of transactions of BBB corporate bonds by small investors who buy and sell bonds at below three billion won exceeded six trillion won.

Lee Jin-oh, a senior researcher of KIS Pricing Incorporation, said, “There are many people who buy bonds despite the high risk, thinking, ‘Does a company really go bankrupt?’ and the demands for gaining profits of five to eight percent through bond investment, which are twice the bank’s interest rate, are soaring.”

The issuance of BBB corporate bonds has increased by 48.4 percent (3.2638 trillion won) compared to last year (2.1997 trillion won).

In particular, BBB corporate bonds issued by construction companies increased by 75.9 percent compared to last year (1.1447 trillion won), amounting to 2.137 trillion won (61.7 percent of total issuance). The reason is because there are many construction companies that wanted to secure business funds in advance for the special demand regarding the capital relocation.

However, BBB corporate bonds issued by construction companies are treated as risky corporate bonds in the bond market because a capital relocation plan led to nothing, and construction cycles have shown a downward pattern.

People in the bond market forecast that there is a possibility of a situation in which construction corporate bonds with similar credit rankings are heavily put on the market, and the price of total bonds declines significantly.

Yim Kyeong-mook, a researcher of the Korea Development Institute said, “Investors misunderstand that bonds are absolutely safe, but the market can be severely shocked as this misunderstanding disappears when a company goes bankrupt.”

BBB corporate bonds are divided into “BBB+,” “BBB0,” and “BBB-.” Corporate credit ranking includes 18 steps ranging from AAA to D. Above “BBB-“ is classified as “investment ranking” and below “BBB-“ as “speculation ranking.”

legman@donga.com