Flood of New Capital Securities Issuance by Large Corporations... 'Partial' Financial Improvement to Avoid Capital Increase

Hyosung Chemical, Lotte Culture, SGC Tech Issue Bonds One After Another
Debt Ratio Exceeding 3000% Attempts Reduction
"Minimal Practical Financial Improvement Effect" Criticized

Issuance of new types of capital securities (perpetual bonds) by large corporations is increasing. In the past 10 days alone, Hyosung Chemical, Lotte Cultureworks, and SGC Tech Construction have issued large-scale perpetual bonds to reduce their debt ratios. However, there are ongoing criticisms that issuing perpetual bonds cannot be regarded as a fundamental improvement in financial structure.

Large Corporations Continue Issuing Perpetual Bonds

According to the investment banking (IB) industry on the 29th, SGC Tech Construction, an affiliate of the SGC Group, issued 80 billion KRW worth of perpetual bonds on the 26th. The bond maturity is over 30 years with possible extensions. However, from 2027, three years later, a call option (early redemption right) can be exercised to repay principal and interest before maturity. If the call option is not exercised, a penalty interest of 50 basis points (1bp=0.01%) per year will be added to the base interest rate of 8.5%.

Hyosung Chemical issued 100 billion KRW worth of perpetual bonds with a maturity of over 30 years on the 22nd. The interest rate is 8.30%, and if the call option is not exercised, a penalty interest of 350bp (3.50%) will be imposed after two years. After five years, an additional 450bp, and after ten years, an extra 550bp interest must be paid. The annual interest can rise up to a maximum of 21.80%.

Lotte Cultureworks issued 200 billion KRW worth of perpetual bonds on the 20th with support from Lotte Shopping. The initial issuance interest rate was 6.06%, and if the call option is not exercised after three years, the interest rate must be increased by 50bp annually.

Issuing Perpetual Bonds to Lower Debt Ratios Soaring by Thousands of Percent

The reason these large corporations issue perpetual bonds is to lower their debt ratios. In the case of perpetual bonds, if penalty interest is paid, repayment is not required for a long period, allowing the issuance amount to be recognized as equity in accounting. Even without a paid-in capital increase, if accounting equity increases, the debt ratio decreases.

Hyosung Chemical faced extreme financial instability with its debt ratio once approaching 9941%, prompting the issuance of perpetual bonds. Starting with 70 billion KRW worth of perpetual bonds issued in August last year, an additional 30 billion KRW was issued in September, and 100 billion KRW more this month. This amounts to 200 billion KRW worth of perpetual bonds issued over the past seven months.

Lotte Cultureworks also issued a large amount of perpetual bonds as its financial condition worsened, with a debt ratio exceeding 3500% due to poor performance in the cinema business. Over the past year, it issued about 350 billion KRW worth of perpetual bonds several times in hundreds of billions KRW increments.

Hyosung Chemical and Lotte Cultureworks have expanded their capital relying on perpetual bonds, increasing the proportion of perpetual bonds within their equity capital. Capital raised through new share issuance such as paid-in capital increases has been eroded, and perpetual bonds, which are essentially borrowings, now constitute most of their capital.

SGC Tech Construction issued perpetual bonds after its financial structure deteriorated due to real estate project financing (PF) defaults. An IB industry official said, "Perpetual bonds are classified as equity in accounting, but in reality, they correspond to borrowings," adding, "It is difficult to view the issuance of perpetual bonds as a genuine improvement in financial structure."

Avoidance of Paid-in Capital Increase... Fundamental Financial Improvement Needed

For this reason, there are repeated criticisms that perpetual bonds are merely a means to avoid paid-in capital increases. Hyosung Chemical, in addition to issuing perpetual bonds, expanded capital by 150 billion KRW through land revaluation last year and conducted a 50 billion KRW third-party allotment paid-in capital increase. However, due to consecutive net losses, it relies more on perpetual bonds than on capital increases.

Lotte Cultureworks has improved its financial situation relying solely on perpetual bonds without ever conducting a capital increase despite its extremely deteriorated financial condition. It is observed that it is difficult for the major shareholder, Lotte Shopping, and Jeong Seong, an advisor to Hyundai Motor Group (Innocean), to make new investments.

An IB industry official explained, "If a paid-in capital increase is conducted, existing shareholders including major shareholders must inject new capital (new money) proportionally to their shareholding, or else major shareholders must accept dilution of their shares," adding, "Most companies try to avoid paid-in capital increases to reduce the burden of new capital injection on major shareholders."

The official said, "Even if perpetual bonds are repeatedly issued and the debt ratio is lowered, it is difficult to regard the financial structure as improved," and "To be recognized by the market for efforts to improve financial structure, substantial efforts such as asset sales or paid-in capital increases are necessary."