'Corona Shock' Sparks Growing Concerns Over Corporate Credit Rating Downgrades
[Asia Economy Reporter Kangwook Cho] "The current financial market is like a calm before the storm. Risk management and supervision are more important than ever." The Korea Institute of Finance recently diagnosed that due to poor corporate earnings and business conditions, abundant liquidity is more likely to flow into financial assets and the real estate market rather than corporate investment.
Credit Risk Index at Global Financial Crisis Level Amid Record-Breaking Daily Loan Amounts
As signs of corporate insolvency have become clear due to the direct impact of the COVID-19 pandemic, warning signals about credit crunch in the financial market have been triggered. The credit risk index has surpassed the level seen during the global financial crisis amid record-breaking daily loan amounts. Additionally, the number of marginal companies has reached an all-time high, and companies facing poor earnings have seen their credit ratings downgraded, leading to increased market rejection. As loan and interest repayment deferrals granted to companies and small business owners are set to end next year, concerns have been raised about a potential chain reaction of insolvency tsunami. Moody's warned last month that none of the Korean companies had a positive credit rating.
According to the financial sector on the 30th, the amount of long-term commercial paper (CP) issued in the market this year exceeds approximately 3.6 trillion won. This is about twice the total of 1.76 trillion won issued last year. As borrowing conditions worsen due to poor earnings, more companies are raising long-term funds through CP.
Among large corporations, Lotte Group is a representative case that shifted its financing strategy from corporate bonds to long-term CP. This year, eight Lotte Group affiliates have issued long-term CP, including Lotte Shopping, Hotel Lotte, Lotte Global Logistics, Lotte Himart, Busan Lotte Hotel, Lotte Aluminum, Lotte GRS, and Lotte Autolis. The total amount has exceeded 1 trillion won.
Son Byung-du, Vice Chairman of the Financial Services Commission, stated at the 27th Financial Risk Response Meeting held on the 28th, "The spread of non-investment grade corporate bonds is narrowing more slowly compared to investment-grade bonds, and the issuance amount has not reached last year's level," adding, "There were also three cases of demand forecast shortfalls in vulnerable industries this month." He further noted, "There have been some cases where CP issuance has been used as a substitute for corporate bond issuance."
Some experts point out that the crisis may begin in the short-term financial markets such as CP and promissory notes. Lim Hyung-jun, Senior Research Fellow at the Korea Institute of Finance, explained, "If the credit market tightens due to prolonged corporate earnings decline and credit rating downgrades, the crisis is more likely to start in the CP and promissory note markets rather than the long-term corporate bond market," adding, "As seen in past bankruptcies of Woongjin, LIG, and Dongyang, crises mostly originate in short-term financial markets when corporate funding structures are weak."
Some Illusory Effects in Financial Industry Soundness Indicators... Greater Concerns for Next Year
The real problem is next year when corporate insolvency is expected to intensify. Hana Financial Management Research Institute pointed out in its recently released '2021 Financial Industry Outlook' report that soundness indicators across the financial industry partly reflect illusory effects and concerns about potential insolvency remain significant.
In fact, corporate loan increases have exceeded 100 trillion won so far this year. According to the Bank of Korea, corporate loan increases from January to September this year reached 97.1 trillion won, a record high. This figure is 1.5 times higher than the previous record during the 2008 global financial crisis (64.3 trillion won). Meanwhile, idle funds without suitable investment destinations have surpassed 1,200 trillion won. The number of marginal companies unable to pay even interest from annual profits is expected to increase from one in three last year. Especially, when COVID-19 financial regulatory relief measures such as loan maturity extensions, interest repayment deferrals, liquidity coverage ratio (LCR) regulation easing, and loan-to-deposit ratio regulation relaxation end next year, hidden insolvency factors are expected to surface all at once.
Baek Jong-ho, Research Fellow at Hana Financial Management Research Institute, warned, "Risk management is necessary in preparation for after June next year when maturity extensions, interest repayment deferrals, and various regulatory easing measures conclude," adding, "While the increase in banks' loan loss costs is a problem, the possibility of insolvency in the secondary financial sector is even greater."
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