High-Net-Worth Individuals 'Sweep Up'... New Hybrid Capital Securities [AK Radio]

High-Yield Hybrid Securities with Characteristics of Stocks and Bonds
Massive Issuance by Financial Firms...Risk of Principal Loss if Designated as Insolvent Institution
No Maturity or 30 Years, but Usually Repaid in the 5th Year

Recently, Contingent Convertible Bonds (CoCo Bonds) have rapidly increased in issuance and gained popularity among investors in the financial market. Especially among high-net-worth individuals, interest in this product is rising, and some financial experts are also recommending CoCo Bonds as a financial investment product.

What are Contingent Convertible Bonds?

Contingent Convertible Bonds are financial instruments that possess characteristics of both stocks and bonds. Like bonds, they pay a fixed interest or dividend annually, but like stocks, they have no maturity date. Due to these features, they are often called "hybrid securities" and are a type of "contingent capital securities" that can have their principal written down or converted into common stock under certain conditions.

If the issuing company is designated as a distressed financial institution, the investor's principal may be automatically written down or converted into common stock. Because of this condition, these securities are referred to by the English abbreviation "CoCo Bond (Contingent Convertible Bond)." Essentially, they are bonds, but there is a risk that investors may not recover their principal if the company goes bankrupt or is designated as a distressed financial institution.

Reasons for Increased Issuance and Popularity

With the Bank of Korea lowering the base interest rate, the era of high interest rates has ended, leading more people to seek investment opportunities. Among these, financial companies are increasingly issuing CoCo Bonds as a means of capital augmentation, and the volume of issuance continues to rise. Recently, Woori Financial Group, Dongyang Life Insurance, and Hanwha Life Insurance have issued these products, and some large corporations have also issued CoCo Bonds for fundraising purposes.

The main reason for the popularity of CoCo Bonds is their high interest rates. As subordinated bonds with a lower repayment priority than senior bonds, they offer higher interest rates. Currently, bank deposit interest rates are formed in the low 3% range, whereas CoCo Bonds always offer interest rates higher than deposit rates. This has attracted high-net-worth individuals to these products, and in some securities firms, the products have sold out immediately upon issuance.

Additionally, CoCo Bonds allow investors to gain capital gains through bond price appreciation, and capital gains from trading are exempt from taxation. Especially when the base interest rate falls, bond prices tend to rise, making these products attractive to investors seeking stable returns while hedging against market volatility.

Structure of Contingent Convertible Bonds

The basic structure of CoCo Bonds is as follows. Investors in this product do not have a principal repayment claim against the issuing company, but the issuer may exercise a "call option" to repay the principal after a certain period. For example, if a financial holding company with an AA rating issues a 5-year CoCo Bond with a 5% annual interest rate and quarterly interest payments, the investor receives interest every three months for five years, after which the issuer may exercise the call option to return the principal to the investor.

However, since the call option is at the issuer's discretion, if the issuer does not exercise it, the principal repayment may be delayed. In fact, there were cases where Woori Bank in 2009 and Heungkuk Life Insurance in 2022 did not exercise their call options. This poses a risk that investors’ funds may be tied up longer than expected.

Another important characteristic of CoCo Bonds is that they either have no maturity or have a nominal maturity typically set at 30 years. Although it has become customary for issuers to exercise the call option and repay funds after five years, investors should be aware of this when investing.

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Risks of Contingent Convertible Bonds

While CoCo Bonds offer high returns, they also carry risks. The greatest risk is that if the issuer is designated as a distressed financial institution or goes bankrupt, investors may not recover their principal. As subordinated bonds, CoCo Bonds have the lowest priority in repayment. In other words, repayment is only possible if other creditors are paid first and there are remaining funds.

Therefore, investors should carefully examine the credit rating and financial condition of the issuer. CoCo Bonds issued by financial companies rated AA or higher are considered relatively safe, but this assessment is based on historical data, and the possibility of the financial institution becoming distressed cannot be ruled out.

Moreover, if interest rates decline, the interest rates on CoCo Bonds may also decrease. Since CoCo Bonds issued as public corporate bonds are priced based on market interest rates through demand forecasting, a drop in market rates inevitably affects the issuance rates. Thus, during periods of falling interest rates, maintaining absolutely high interest rates is difficult, which investors should keep in mind.

Approach for General Investors

Although CoCo Bonds may seem like products only accessible to high-net-worth individuals, general investors can also invest with small amounts. They can be purchased through securities firm branches, HTS (Home Trading System), or MTS (Mobile Trading System), with minimum investments possible in units as low as 1,000 KRW. Additionally, interest payments are made every one or three months, making them suitable for retirees who need regular cash flow.

CoCo Bonds: High Risk, High Return Products

CoCo Bonds have gained great popularity amid falling interest rates and increased interest in financial investments. They offer high interest rates and potential capital gains through bond price appreciation, providing relatively stable returns. However, as subordinated bonds, they carry risks related to the issuer’s creditworthiness and whether the call option is exercised.

Therefore, investors should carefully review the issuer’s credit rating, financial condition, product structure, and market interest rate trends before investing in CoCo Bonds.