The Value Master 2008-1 deal converts five fixed rate Korean won bond issues into a U.S. dollar floating rate bond guaranteed by the Korean Development Bank. The underlying fixed rate bonds are issued by Shinhan Card Co. (owned by Shinhan Financial Group, ticker 055550 in Seoul), Samsung Card (ticker 029780), Nong Shim Holdings (ticker 072710 in Seoul), Shinhan Capital (also owned by Shinhan Financial Group), and IBK Capital, which is almost 100% owned by Industrial Bank of Korea (ticker 024110).
There are a number of things about this deal that are unique compared to the run of the mill CDO deal that many have blamed for the recent financial crisis. The first is the currency transformation from Korean won fixed rate to U.S. dollar floating rate. The second is the Korean Development Bank guarantee, since none of these firms is the kind of exporter that would normally be supported by the KDB. The third unique factor is the very small number of reference names underlying this deal (5), compared to the much larger number of names typical in both cash flow and synthetic CDOs. The fourth factor is that the deal is not tranched like a normal CDO.
This is not an investor or rating agency analysis but, instead, a brief note on what risks one would find in a deal like this. We list them here:
- KDB’s credit spread is closely linked to the Korean Won Exchange Rate: Our analysis in Chapter 4 of Credit Risk Models and the Basel Accords (van Deventer and Imai, John Wiley & Sons, 2003) showed that KDB credit spreads are very tightly tied to the Korean won exchange rate, with a t-score equivalent of more than 51 standard deviations of statistical significance through the Asian crisis
- Four of the firms are financial institutions, so there is no industry diversification at all.
- Two of the firms have the same parent, so their default risk is nearly 100% correlated.
- Financial institutions, as we have seen in the current credit crisis and in the 1997-1998 Asia crisis, have default risk that is highly correlated with sovereign risk like that of the KDB.
The key risk factors that would drive the value of this structured deal are easy to summarize:
- Korean-won exchange rate (even though the deal is denominated in dollars and the FX risk is hedged)
- U.S. dollar interest rates
- Korean stock index levels as a general market proxy
- Other macro factors affecting financial institutions in Korea, like commercial real estate prices, home prices,, and the ripple effect on exporters of the KRW exchange rate
The virtue of this deal is its transparency. Unlike CDO-squared or CDOs of mortgage-backed security tranches, it’s physically possible (quite easy in fact) to model this deal from the bottoms up and to analyze the compound risk that the underlying reference names and the KDB fail to pay at the same time. Because they depend to a high degree on common macro factors, their default risk correlation on the Kamakura Risk Information Services web site is very high. Nonetheless, the possibility of “bottoms up” transaction level analysis is a big plus and it represents best practice in structured deal valuation and risk assessment.
Mr. T and other readers, comments and suggestions welcome at info@kamakuraco.com.
Donald R. van Deventer
Kamakura Corporation
June 24, 2009