[Reporter’s Notebook] MBK Fallout Spreads to Lotte Insurance

Lotte Insurance's plan to exercise a call option (early redemption right) on 90 billion won worth of subordinated bonds has been put on hold. Although early redemption is customary, financial authorities did not approve the move, citing concerns that Lotte Insurance's capital ratio would decline. The market was rattled, recalling the past incident in which Heungkuk Life failed to exercise the call option on its hybrid capital securities. Financial regulators appear to be paying close attention to the fact that JKL Partners, a private equity fund, is the largest shareholder of Lotte Insurance. Lee Sehoon, Senior Deputy Governor of the Financial Supervisory Service, commented, "Lotte Insurance's governance is composed of financial investors, so I suspect that maximizing short-term shareholder profit may be a higher priority than long-term stability."

Lee's remarks seem to reflect public criticism of "eat-and-run" practices, which came to the fore during the Homeplus incident involving MBK Partners. In order to meet the insurance company's capital adequacy ratio (K-ICS) requirements, capital must be increased; however, if a capital increase is carried out, shareholders inevitably face short-term dilution of their equity value. Therefore, JKL Partners has little incentive to voluntarily inject new capital. Moreover, it has already been six years since JKL Partners acquired Lotte Insurance, and a sale is now being discussed, which further diminishes their motivation.

However, it is not easy to resist the demands of financial authorities while operating a financial business. Ultimately, Lotte Insurance and JKL Partners are considering ways to raise capital in the second half of the year. JKL Partners may use internal funds from the fund that invested in Lotte Insurance, or, if that is not feasible, may inject capital from other funds. In the latter case, they would need to obtain approval from each of the other funds' limited partners (LPs). Even if they barely secure the necessary approvals, the valuation of Lotte Insurance during the investment process becomes a sensitive issue. The larger the capital injection, the higher the sale price, making it more difficult to find a buyer. The situation quickly turns into a complex equation.

In fact, the authorities have simply done their job. Given the importance of financial soundness in the insurance industry, strict management of capital ratios is essential. However, the somewhat abrupt manner in which the process was handled is regrettable. In February, when Lotte Insurance sought to strengthen its capital by issuing 100 billion won worth of subordinated bonds, the Financial Supervisory Service forced the company to withdraw the day before the demand forecast, citing insufficient disclosure in the related securities registration statement. From Lotte Insurance's perspective, this led to an unexpected disruption in its capital-raising efforts. It is also disappointing that, despite the Heungkuk Life incident in 2022, financial authorities have not revised Korea's unique custom of early redemption.

Most concerning is the emphasis on the characteristics of the largest shareholder, which has turned private equity funds into a public enemy. As a result of this incident, the private equity industry already feels it has become a clear social "villain." A representative from a private equity management company (PE) said, "Seeing the authorities deny early redemption and launch a sweeping criticism, even at the risk of undermining trust in the capital-raising market, I can feel that public scrutiny has become harsher." However, criticizing private equity funds does not solve the early redemption issue. On the contrary, it could shrink the private equity market itself, which has been nurtured over the past 20 years to counter foreign capital. Even if it takes time, the most effective way to minimize future problems and controversy is to directly improve the systems and practices related to the issuance of capital securities such as subordinated bonds.