Rising Interest Rates... Capital Companies Sigh Over Potential Increase in Funding Costs

Hankyung Research Institute "Capital Companies' Operating Profit Plummets Assuming 0.5%p Year-End Interest Rate Hike"

[Asia Economy Reporter Yu Je-hoon] An analysis has emerged that the profitability of domestic capital companies could plummet sharply due to the impact of rising interest rates. With interest rates expected to continue rising throughout the year, the interest expenses on borrowed debt are increasing, which could significantly reduce operating profits.

According to the financial sector on the 3rd, Korea Ratings issued a report titled "How Much Will Interest Expense Burden Increase for Capital Companies During Interest Rate Rise?" on the 27th of last month, stating, "Since the base interest rate was raised again this year, market interest rates are rapidly rising again, and the funding cost burden on capital companies is also increasing."

As of the end of last month, the market interest rate for 3-year maturity AA- rated specialized credit finance company bonds (based on private bond valuation by market price) was 2.954%, up about 1.4 percentage points from the end of 2020 (1.521%) and about 0.3 percentage points from the end of last year (2.586%). Typically, capital companies, which do not have deposit functions, rely on market funding, so interest rate fluctuations have an absolute impact on profitability.

Korea Ratings estimated that assuming an interest rate increase of 0.5 percentage points by the end of this year compared to the beginning of the year, a 10% increase in borrowed debt balance compared to the end of Q3 last year, operating yield remaining the same as the previous year, and total assets increasing by 10%, the operating profits of 31 surveyed capital companies would decrease by 7-30% year-on-year depending on credit rating.

For AA- rated capital companies, the borrowed debt interest rate is expected to rise by 0.46 percentage points by year-end, interest expenses to increase by 36%, and operating profits to decrease by 7%. Additionally, for A rated capital companies, the borrowed debt interest rate is expected to rise by 0.50 percentage points, interest expenses to increase by 34%, and operating profits to decrease by 9%. Especially, if the funding environment worsens and corporate bonds are issued at the average interest rate of private bond valuation companies (market average rate), interest expenses are expected to increase by 39% and operating profits to decrease by 13%, Korea Ratings predicted.

For BBB rated capital companies, if the corporate bond issuance spread remains at the current level, the borrowed debt interest rate is expected to rise by 0.60 percentage points by the end of this year, with interest expenses and operating profits changing by +29% and -5%, respectively. Furthermore, if corporate bonds are issued at the market average rate, the borrowed debt interest rate is expected to rise by 1.60 percentage points, with interest expenses and operating profits changing by +61% and -30%, respectively.

Korea Ratings stated, "If capital companies can flexibly adjust their operating yields, there would be no change in interest margins despite rising funding costs. However, considering intensified competition within and outside the industry, it will not be easy to flexibly raise operating yields." They added, "If the funding environment deteriorates in the future, AA- rated capital companies could somewhat alleviate the pressure of rising funding costs through asset-backed securities (ABS) issuance, and A rated capital companies with high affiliate guarantees and borrowings could ease the pressure through liquidity support from affiliates."

This content was produced with the assistance of AI translation services.