[Brokerage Earnings Shock] ① Numerous Halvings... Interest Rate Bomb and Real Estate PF Add to Misfortunes

Ukraine War, US-Originated High Interest Rates, and Legoland Incident Overlap
Small and Medium Securities Firms with High Real Estate PF Proportion Face Liquidity Crisis

[Asia Economy Reporter Son Sunhee] Last year, the operating profits of domestic securities firms plummeted sharply. The sudden Russian invasion of Ukraine, the Federal Reserve's (Fed) aggressive interest rate hikes, and high inflation?all significant economic uncertainties?combined to cause a sluggish stock market. In particular, with the real estate market also weakening and the Legoland incident compounding the situation, the bond market fell into panic, pushing securities firms with a high proportion of real estate project financing (PF) into liquidity crises.

According to the Financial Supervisory Service's electronic disclosure system on the 9th, most domestic securities firms that have disclosed their performance for last year received dismal results at the level of an 'earnings shock.' Mirae Asset Securities, considered the industry's largest by total capital, posted an operating profit of 845.9 billion KRW last year, down 43.1% from 1.4854 trillion KRW in 2021. During the same period, NH Investment & Securities' operating profit also fell nearly 60%, from 1.2939 trillion KRW to 521.3 billion KRW. Samsung Securities recorded 423.9 billion KRW, down 56.1%, and Shinhan Investment Corp. posted 120 billion KRW, down 79.5%. KB Securities' operating profit (224.9 billion KRW) plunged more than 70%, marking the largest decline among large securities firms with over 4 trillion KRW in equity capital disclosed so far. The situations of Korea Investment & Securities and Hana Securities are expected to be similarly bleak.

The impact was even greater on relatively smaller mid-sized securities firms. For example, Hanwha Investment & Securities' operating profit dropped nearly 80%, from 208.8 billion KRW in 2021 to 43.8 billion KRW last year. Its net income turned negative, recording a loss of 47.6 billion KRW. DB Financial Investment's operating profit shrank by 85% year-on-year to 12.5 billion KRW. SK Securities' operating profit fell 97% to just 1.4 billion KRW.

The poor performance of securities firms was virtually anticipated. Last year, the KOSPI fell 24.9% compared to the end of the previous year?the largest drop in 14 years since the 2008 global financial crisis (-40.73%). As the stock market weakened, investors' trading volumes decreased, causing brokerage revenues, the primary income source for securities firms, to plummet. This trend was not limited to Korea but was global. As the market deteriorated, attention shifted to relatively safer assets, leading to underwhelming performance in asset management divisions and a simultaneous decline in fees related to overseas financial products and entrusted assets. The base effect from the record profits securities firms posted during the asset boom in 2021, right after the COVID-19 outbreak, also played a significant role.

Risks Persist... Real Estate PF as a 'Time Bomb'

One notable aspect of securities firms' performance last year was that while profitability sharply declined, most firms saw a significant increase in sales. This was due to a surge in trading volumes of derivatives such as overseas government bonds, dollar futures, and equity-linked securities (ELS) amid heightened market volatility. Since all trading during derivatives operations is recorded as sales in accounting, this increase in sales holds little practical significance.

Similarly, the steep drop in operating profit should be viewed differently concerning bond assets held. Last year, the Fed raised interest rates consecutively at the steepest pace in history, causing valuation losses on bond assets held by securities firms to balloon. Although no actual cash losses occurred, accounting standards require reflecting valuation losses at the time of financial statement preparation. The valuation losses on bond assets held by securities firms can be partially recovered in accounting terms once interest rates stabilize. A securities firm official said, "Last year, interest rates surged so much that bond firms suffered large losses just by holding bonds," adding, "It was less about who managed better and more about who lost less due to holding fewer bond assets." However, he added, "If interest rates stabilize this year, there will be some valuation gains on held bonds, though not enough to fully offset last year's losses."

The real problem lies in non-performing bonds, notably real estate PF. Following the COVID-19 outbreak, the low-interest-rate environment led to a boom in the real estate market. During this period, securities firms eagerly entered the real estate PF business, which was once considered a lucrative sector.

However, the situation changed rapidly as the real estate market froze in recent months. The rise in benchmark interest rates reduced the viability of existing real estate PF projects, and unsold housing issues emerged in various locations, raising concerns over losses. Particularly, mid-sized securities firms with a high proportion of relatively risky mezzanine and subordinate PF holdings experienced sudden liquidity crises last year. A representative case is Daol Investment & Securities, known as a 'small powerhouse' in the real estate PF market, which turned to a loss of 42.4 billion KRW in Q4 last year. Following the liquidity crisis, it sold its affiliate Daol Credit Information last month and is currently in the process of selling Daol Investment. It also conducted voluntary retirement at the end of last year. Securities firms that invested in mezzanine and subordinate bonds aiming for high returns inevitably suffered greater damage. Industry insiders pessimistically say, "The real estate PF-related defaults are just beginning."

Securities Industry Aims for Rebound This Year... 'Risk Management and Profitability Recovery' Are Crucial

Securities firms are expected to focus primarily on risk management to improve performance this year. Although the domestic stock market has shown a rebound trend due to foreign investors' buying at the beginning of the year, economic uncertainties remain significant, including the Russia-Ukraine war, high inflation, and supply chain risks. A securities firm official said, "Last year, the market behaved erratically, but the deterioration in performance was ultimately due to a lack of systematic risk management," adding, "Some securities firms involved in private equity fund scandals have not yet resolved their issues, and since the economic situation has not changed much from last year, most firms will likely adopt a conservative stance and concentrate on risk management."

At least the recent stability in the short-term bond market offers some consolation. Securities firms have taken this opportunity to issue short-term corporate bonds early in the year to secure liquidity. There is also strong interest in new businesses such as issuing security tokens (STO) to diversify revenue streams. This involves securitizing tangible assets like real estate or artworks and issuing them in token form. Recently, regulatory authorities have permitted STO issuance and released guidelines, stirring excitement in the industry. A system for STO trading is expected to be established as early as the second half of this year. The market views these moves by securities firms positively. The KRX Securities Index, announced by the Korea Exchange, stood at 643.86 (closing price as of February 8), rising nearly 16% since the beginning of the year.