South Korea nascent hybrid market is experiencing some growing pains after the Financial Services Commission (FSC) questioned the country’s first corporate hybrid deal after it was completed.
Doosan Infracore Co. printed a US$500 million, 30-year non call five hybrid on September 25 that was priced with a 3.328% coupon. The understanding that it would have an equity component was considered a big attraction for the company, according to bankers on the deal. To entice investors, the deal received a credit enhancement from Korea Development Bank, Woori Bank and Hana Bank.
The deal heralded a new era for Korean companies seeking to raise funds without diluting their shares or affecting their credit ratings. Unrated corporations such as Korean Air and Hanjin Shipping were also said to be arranging similar deals, said industry bankers.
But now the FSC is saying that the hybrid should not be considered as equity on Doosan’s books, according to a regulatory official, a banker familiar with the deal and two credit analysts. The bond adheres to International Financial Reporting Standards, according to a credit analyst.
More than a month after the deal was printed, an FSC official told the Korea Economic Daily that Doosan’s hybrids should be considered debt instead of equity because it did not have a clause that would have made investors in the hybrid subordinate to investors in Doosan’s senior debt. Credit rating agencies including the Seoul-based Korea Ratings Agency also said it will consider it as 100% debt because of the possibility that the issuer would call the bond, or the investor would exercise their put options and therefore force the bond to mature.
An FSC official said that it is up to the Korea Accounting Standards Board to clarify and announce the final decision, adding that the date has not been set. A November 8 announcement has been delayed.
“The issuer is probably, if they are able to, they will probably pay at five years because of the large step-up. If there is a sizable step-up date, then that date is considered the effective maturity on the bond. And our assumption is that the bond will not stay over five years,” said the credit analyst. “But even if they don’t pay, the investors will want the banks to pay up at the end of five years because the issuer credit rating is much lower than the A-rated banks.”
Doosan’s deal requires the company to step up payments to 500 basis points (bp) after five years, and an additional 200bp two years later.
The Financial Supervisory Service (FSS) has declined to comment, saying discussions on whether to consider Doosan’s hybrid as debt or equity are still ongoing. The FSS had approved the Doosan hybrid to count as equity on their balance sheets, an FSS official told Asiamoney PLUS on November 26.
The clash in opinions between the FSS and the FSC has distressed bankers who are in talks with Korean companies on hybrid deals, who are shocked and angered by the Korean government’s move.
“This shows that there is an issue with credibility in [the government of] South Korea and challenges whether the country is even capable of even following IFRS,” according to a banker with knowledge of the deal. “The regulator, the FSS, said it is counting it [the Doosan hybrid] as equity and that it adheres to IFRS standards, but for the Financial Services Commission to analyse it and say that it’s not just because it is not subordinated debt or has a high step up, doesn’t make any sense whatsoever.”
“We’ve definitely seen other deals that are unsubordinated and have step-ups of 500 basis points in other jurisdictions that have been agreed that they adhere to IFRS standards. What’s the real reason why they’re against it?”
The banker said concern over whether banks should be taking on guarantees of equity might have been a legitimate concern, but to unravel a deal after it had been approved by financial regulators was a problem.
“Once you had the approvals in clearly and you have a change in the regulation stance, it does shake a lot of confidence on the next issue. That will make it more confusing,” according to a banker away from the deal.
A risk to banks
“Maybe they [the FSC] didn’t want the banks to too much of those transactions,” according to the credit analyst.
South Korea’s government is trying to curb rising household debt, after loan delinquency ratios rose above 1% for the first time in six years and corporate loan defaults increased to 2% for the first time since 2003.
“The fact that you have banks guarantee equity is sort of quite aggressive to me,” according to another banker. “It can only mean that the banks guaranteeing it are buying equity. The cost for the banks is very high.”
Doosan’s hybrids were trading at par on November 26, which will not cause too much in losses for investors if they were to call the bond now, according to a rival banker.
Although a subsequent decision from the Korea Accounting Board may not trigger any action on Doosan’s deal, the future for Korean hybrids may be dim at best if the Korea Accounting Board deems Doosan’s hybrid as debt.
“A lot of the deals that are in the pipeline will be difficult [to complete.] It won’t be a popular form of securities that companies will want to touch,” said the banker. “It’s a pity because hybrids would be good for a lot of companies in Korea like SK Telecom, Posco or Lotte Shopping to do. These companies have strong credit profiles but need to raise capital and are on credit watches.”
But the FSC may be more willing to allow the hybrid market to develop in South Korea if bank guarantees wither away in future deals.
“Other jurisdictions don’t use bank guarantees in hybrid deals so doing away with them is the right way to go. Maybe then the FSC will loosen its grip,” said a banker with knowledge of the deal.