Even with Low Credit Ratings, High Interest Rates... Popularity of New Capital Securities and Subordinated Bonds

Financial Companies Secure Principal and Interest Repayment
Individual Investors Flock to Long-Term Government Bonds as Alternative Investment

[Asia Economy Reporter Lim Jeong-su] The number of individual investors investing in hybrid capital securities and subordinated bonds (subordinated debt) is increasing. Since most issuers of subordinated bonds are financial companies, the risk of principal and interest repayment failure is low, while the interest rates are relatively high, attracting popularity.

According to the securities industry on the 7th, trading of subordinated bonds is actively taking place in both on-exchange and over-the-counter retail bond markets. Most subordinated bonds traded in the bond market the previous day were bought and sold at prices higher (lower interest rates) than the bond prices (interest rates, average market interest rates) evaluated by private rating agencies. This is interpreted as leading to price increases (interest rate declines) due to increased demand compared to relatively limited supply.

Corporate bonds issued by KB Financial Group are traded at the mid-3% range, while conditional capital securities, a type of hybrid securities, were mostly traded at the high 4% range. Even these were traded at 8-9 basis points (1bp=0.01 percentage points) lower than the average market interest rates.

Considering that hybrid capital securities issued by Shinhan Financial Group last month were issued at the low 5% range, the circulating interest rates of hybrid securities have significantly decreased within two weeks. As the perception that these are high-interest financial holding company bonds spread among individual investors, demand surged, causing prices to rise and circulating interest rates to fall.

Subordinated bonds issued by insurance companies are also popular. Hybrid capital securities with a 30-year maturity issued by Hyundai Marine & Fire Insurance in 2018 were traded at around 4.39%, about 57 basis points lower than the average market interest rates. Subordinated bonds issued by Hyundai Marine & Fire Insurance, Lotte Insurance, and Fubon Hyundai Life Insurance are also being traded actively.

Subordinated bonds are mainly issued by financial companies to improve capital ratios such as the BIS ratio (financial holding companies, banks) or the solvency margin ratio (RBC, insurance companies). They are classified as bonds with lower repayment priority compared to senior bonds, thus having lower repayment enforceability. Due to these characteristics, their credit ratings are set at least one notch lower than the issuer’s credit rating, resulting in higher interest rates.

Since they have characteristics of both capital and debt in accounting, financial companies or corporations can include them as equity when calculating accounting debt ratios or financial company capital ratios. Hybrid securities or conditional capital securities are recognized as capital until redemption, but subordinated bonds have a decreasing proportion recognized as capital each year starting from five years before maturity.

A bond market official said, "As long-term government bond yields stabilize downward, individual investors’ interest has shifted to relatively safe yet high-interest subordinated bonds," adding, "As trading increases, circulating interest rates are rapidly declining, and investor interest is expected to continue for some time."