Asiana Airlines Inc., South Korea’s No. 2 carrier, is increasingly dogged by rising borrowing costs just as stiff competition from low-cost rivals looms over a potential rebound in its China business.

The Bank of Korea’s first interest-rate increase since 2011 on Thursday may add to the Seoul-based carrier’s woes by pushing up funding costs, according to Shinhan Investment Corp. The premium that investors demand to hold Asiana’s bonds jumped last week after its credit rating was cut to BBB-, one level above junk grade, by Korea Investors Service.

China restricted group tours to South Korea after the latter deployed the U.S. anti-missile system Thaad, but the two nations agreed to put aside the dispute in October. While that may help boost its Chinese business, concern remains about the health of its balance sheet: Asiana’s short-term debt made up 47.5 percent of its total at the end of September from 23.2 percent in 2013, providing less leeway for the firm to make repayments, according to KIS.

“The BOK rate hike could make it more difficult for lower-rated companies to raise funds considering that absolute yields are rising,” said Kim Sang-hun, a credit analyst at Shinhan Investment in Seoul. “They will likely continue to face a difficult funding environment next year unless the government does something.”

The airline has limited possibility to improve its profits because of the expanding presence of low-cost carriers and its delay in modernizing its fleet, said KIS, the local affiliate of Moody’s Investors Service.

Asiana expects its ratings will be restored as its earnings will likely show a big improvement due to better relations with China and the 2018 Winter Olympics, it said in a text response to Bloomberg.

The yield on Asiana’s 1.5 year-bonds sold in October has surged 31 basis points to 6.531 percent since KIS lowered its rating, according to data compiled by the Korea Financial Investment Association. By comparison, the 4.188 percent notes due April 2019 of Korean Air Lines Co., which is rated BBB+ by KIS, yielded 4.391 percent.

Asiana has more than 500 billion won ($460 million) of straight bonds and commercial paper coming due next year, according to data from Korea Securities Depository. Airlines often need to raise funds to modernize their fleet even when borrowing costs are rising, and such investments don’t always boost their business, according to Shinhan’s Kim.

Funding costs are increasing overall for companies with BBB level ratings as the central bank moves to raise rates. Such firms have had to seek financing options other than issuing straight bonds, such as asset sales. More than half of Asiana’s total outstanding notes were asset-backed securities linked to its accounts receivable, according to its third-quarter financial report. That means the airline is effectively using future cash flow in advance.

The rise of Korean low-cost carriers also threatens Asiana. For the cheaper airlines, the number of passengers on international flights connected to Korea rose 32.3 percent in October from a year earlier, according to the transport ministry. Such passengers on full-service carriers dropped 3 percent.

Asiana and low-cost carriers are also competing on some of the same Asian routes: the region accounted for about 60 percent of Asiana’s total passenger sales in the third quarter. The airline is fighting back by starting a low-cost carrier of its own called Air Seoul Co., as an initial public offering is held for an LCC affiliate of bigger rival Korean Air Lines Co.

“We’ll need to monitor whether Asiana’s budget carrier Air Seoul business is going well,” said Kim at Shinhan Investment. “That’s key for Asiana.”

While investor demand for higher-rated Korean bonds is rising as earnings improve, many institutions are still averse to taking on the risk of holding BBB grade securities.

“BBB+ is the limit for us,” said Kim Hong-joong, head of fixed income at Hanwha Asset Management Co. “Even though demand for corporate bonds with A ratings increased in past months, BBB rated bonds are a different story.”

–With assistance from Kyunghee Park

©2017 Bloomberg L.P.

This article was written by Kyungji Cho from Bloomberg and was legally licensed through the NewsCred publisher network. Please direct all licensing questions to legal@newscred.com.

Photo Credit: Asiana is facing intense competition from low-cost airlines. Pictured is one of the airline's Airbus A321s. lasta29 / Flickr