Banks on Alert Amid Surge in 'Zombie Companies'...Dilemma of Stockpiling Ammo Despite Burden (Comprehensive)

Record High in Zombie Companies
Emergency Measures Including Bank Loan Loss Provisions
Four Major Banks' Subordinated Bonds Near 3 Trillion This Year

[Asia Economy Reporter Kangwook Cho] Amid the aftermath of the novel coronavirus infection (COVID-19), the number of 'zombie companies' surviving on debt has reached an all-time high, prompting major commercial banks to consecutively issue subordinated bonds to stockpile ammunition for potential emergencies. However, concerns are growing that the large-scale issuance of subordinated bonds by banks to bolster capital could backfire by undermining profitability. The Bank for International Settlements (BIS) has also expressed worries that the proliferation of zombie companies could deteriorate the soundness of the Korean financial market.

Four Major Banks Issue 3.5 Trillion Won in Subordinated Bonds This Year, 1.3 Trillion Won More Than Last Year

According to the financial sector on the 28th, the total amount of subordinated bonds issued this year by Korea's four major commercial banks?KB Kookmin, Shinhan, Hana, and Woori?approaches 3 trillion won. Including KB Kookmin Bank’s announcement on the 24th of a planned issuance of $500 million (approximately 600 billion won) in foreign currency amortizing contingent capital securities (subordinated bonds) in the fourth quarter, the total exceeds 3.5 trillion won. This amount surpasses last year’s annual issuance volume of 2.2 trillion won by more than 1 trillion won.

By bank, Shinhan Bank started issuing subordinated bonds in February with 290 billion won, followed by KB Kookmin Bank issuing 400 billion won in March, 450 billion won in May, and another 500 billion won in August. Originally, Kookmin Bank planned to issue $500 million in the second quarter, but postponed the schedule due to deteriorating overseas bond market conditions amid the COVID-19 spread. Hana Bank also issued subordinated bonds worth 350 billion won in March and 340 billion won last month, while Woori Bank issued 300 billion won each in March and June.

The rush by commercial banks to issue subordinated bonds stems from an emergency in managing capital soundness due to provisions for loan losses. Subordinated bonds serve as a means for banks to increase capital. International organizations such as BIS recognize long-term subordinated bonds with maturities of five years or more issued by banks as capital. As of the end of June, Kookmin Bank’s BIS total capital ratio stood at 14.38%, down 1.47 percentage points from the end of last year, marking the lowest level among major banks.

Growing Concerns Over Defaults from Zombie Companies

The problem is that concerns over defaults caused by zombie companies are snowballing. According to the Bank of Korea, the number of zombie companies this year is estimated to exceed 5,000. This is 1,500 more than last year’s record high of 3,475 since related statistics began in 2010. In the worst-case scenario, the Bank of Korea forecasts that two out of every ten companies this year could be zombie companies.

Another burden is that subordinated bonds, which have lower repayment priority and thus require higher interest rates to be sold, could become a future financial pressure for banks. In a situation where it is difficult to generate profits due to COVID-19 financial support, issuing subordinated bonds could increase funding costs and become a burden for banks. However, banks face a dilemma as they cannot stop securing ammunition to support companies financially.

BIS Soundness Alert: "Korea’s Banks Handle Most COVID-19 Financial Demand"

In this context, BIS recently issued a soundness alert for Korean commercial banks, as they handle most of the COVID-19 financial demand. According to the BIS report, all of the increase in domestic private sector debt in the first quarter of this year was accounted for by bank loans.

BIS predicted that if the number of insolvent companies surges, the banks’ 'shock absorption capacity' could become a critical issue. It pointed out that zombie companies, which had low profitability even before COVID-19, are surviving due to low interest rates and government public support.

Jang Woo-ae, a research fellow at IBK Economic Research Institute, explained, "BIS warned that while countries like Luxembourg, Norway, Finland, and Mexico have a high proportion of direct financing, Hong Kong, China, and Korea rely heavily on commercial banks to meet most COVID-19 financial demand, necessitating greater caution in managing soundness."