US bank loans, asset-based credit whet appetite of Korean investors

Aug 18, 2016 (Gmt+09:00)

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South Korean institutional investors are gearing up to raise exposure to U.S. bank loans, collateralized loan obligation (CLO) and commercial mortgage backed securities (CMBS), by lifting the investment limit for the structured products, revising internal regulations, or hiring foreign asset managers.

With U.S. equity markets seen as overvalued, South Korean investors are shifting their eyes to secured lending products issued in the United States, in search of stable cash flows of 4~5% a year, amid the views that the U.S. economy remains stable relative to other investable overseas markets.

Korea Post has recently raised its investment limit for U.S. CLO and CMBS to $800 million. To facilitate the purchase of such structured debt, the government agency has also revised internal regulations to shorten the investment review process for the purchase of CLO and CMBS.

“CLO and CMBS, once issued, are put up at auction and split for sale like international tenders. So we cannot help but buy only $30~40 million a time,” a Korea Post source told the Korea Economic Daily. “Under such circumstances, we have little time to go through the investment review committee one by one, and that’s why we revised our regulations.”

On August 17, Korea Post’s savings unit announced a request for proposal to select three asset management houses that will be in charge of setting up separately managed, offshore accounts to invest in CLO debt tranches. Money earmarked for new CLO purchases through the three asset managers is not included in the $800 million ceiling.

The savings arm of the postal service, which oversees 62.5 trillion won in assets, has invested a total of 10 trillion won in alternative assets: 6.5 trillion won of which are placed in structured bonds and the remaining 3.5 trillion won in real estate, private equity funds and SOC at home and abroad.

For CLOs, Korea Post has been investing in BBB- or above-rated tranches of top CLO managers. The state-run agency prefers debt products paying a coupon rate of about 4%, in consideration of their credit ratings and loan-to-value ratios. “Given the nature of our assets as customers’ savings accounts, stable management is our top priority,” said the source of Korea Post. “We are shunning equity tranches which have the risk of losing money, and prefer fixed rates to floating rates.”

CMBS are expected to offer a coupon rate of about 50 basis points higher than that of CLOs, according to Korea Post. The postal service favors CMBS with the ratings of BBB or above, and less than 50% LTV ratio. “If default occurs, although the possibility is low, equity investors will take losses and after that, we will be able to secure the ownership rights of the building,” said the Korea Post source. “Waiting for a right timing, if we sell the building when its value has risen, we can expect a trading profit.”

Separately, eight other South Korean institutional investors, including insurance companies and savings funds, have recently bought $200 million worth of CLOs from Guggenheim Investments, out of the total $500 million CLOs issued by the asset manager. The purchase consists of senior secured tranches taken by insurers, expected to yield about a 5% internal rate of return (IRR) a year and subordinated tranches that savings funds bought on expectations of a double-digit IRR.

A domestic savings fund source told the Korea Economic Daily that CLO issuance has languished recently in the lack of buyers of equity tranches of the CLO issuance. However, via foreign asset management companies such as Guggenheim, they have little difficulty in securing as much CLO as they want because such asset managers tend to allocate more debt tranches to equity tranche buyers. “Foreign asset management firms that are arranging U.S. CLO investments to South Korean institutional investors amount to 40~50 now,” the source added.

SEES OVER 7% ANNUAL IRR FROM BANK LOAN FUNDS

U.S. bank loans (senior secured loans) also have been appealing to South Korean institutional investors. Although the loans are extended to below-investment grade (BBB-) companies like high-yield bonds, they are low-risk investments because they are senior secured loans. The expected IRR on U.S. bank loans is more than 7% a year, far higher than South Koreaen government bond yields and bank interest rates which stand at the 1% range. Another advantage of bank loans is that most of them carry floating rates, which means possible interest rate hikes will lead to additional gains from the lending.

Korea Scientists and Engineers Mutual-aid Association, Korea Federation of SMEs and Lotte Insurance have invested $30 million apiece in a U.S. bank loan fund raised by Benefit Street Partners in the first half of this year. Separately, National Forestry Cooperative Federation and KDB Life Insurance have committed about 10 billion~20 billion won ($9 million~18 million) each to a floating-rate bank loan fund launched by Babson Capital Management in the United States.

Meanwhile, National Pension Service has been maintaining a certain portion of U.S. asset-based loans in its portfolio, after selecting Oak Hill Capital Partners and Apollo Global Management as general partners three years ago.

By Chang Jae Yoo and Daehun Kim

koreaninvestors@hankyung.com