Securities Industry's 'Profit Bankruptcy Fear' Excessive Shadow... Struggling for Liquidity Recovery and Poor Earnings Next Year

[Asia Economy Reporter Lee Seon-ae] Although concerns about 'profitable insolvency' have been raised in the domestic securities industry, the prevailing view is that such fears are excessive. While securities firms are struggling to secure liquidity, the likelihood of profitable insolvency materializing based on current indicators is considered low. However, next year's performance is expected to decline compared to this year and inevitably show sluggishness.

According to the Financial Statistics Information System on the 8th, as of the second quarter of this year, the adjusted liquidity ratio (including debt guarantees) of most securities firms exceeded 100%. Daol Investment & Securities, the only firm below 100%, secured liquidity above 100% during the third quarter. This means that the current liquid assets held can cover not only current liabilities but also the suspension of asset-backed commercial paper (ABCP) refinancing.

Jeong Tae-jun, a researcher at Yuanta Securities, stated, "Although financial authorities took emergency measures to alleviate the liquidity crunch, theoretically, securities firms could resolve the issue themselves, so the possibility of profitable insolvency is very limited," adding, "Securities firms can handle not only current liabilities but also ABCP refinancing suspension with their current liquid assets."

◆Securities Firms' NCR Ratios Are Healthy... 'Fear Is Excessive'

The shadow of profitable insolvency in the securities industry is mainly due to the potential deterioration of real estate exposure (risk exposure). From the third quarter, banks have stopped new project financing (PF) loans, making it difficult to convert bridge loans into main PF loans, which has spread concerns about real estate defaults. Additionally, starting with the Legoland ABCP default, the suspension of ABCP refinancing across the industry has raised concerns about profitable insolvency. If ABCP refinancing stops, the issuer must absorb it, raising questions about whether sufficient liquidity exists.

Securities firms facing liquidity emergencies have been selling assets such as real estate and bonds and increasing short-term borrowing limits, spreading fear. Regardless of company size, most securities firms have entered emergency management mode, cutting costs such as selling and administrative expenses, consolidating departments, reducing personnel, and pushing for restructuring including converting to non-regular workers. Recently, the Korea Financial Investment Association gathered opinions from major domestic securities firms and requested financial authorities to temporarily ease the net capital ratio (NCR) regulations.

The NCR is calculated by dividing the amount obtained by subtracting total risk from net operating capital by the required capital. If it falls below the standard 100%, financial authorities intervene. Total risk affecting NCR includes market risk, credit risk, and operational risk. Due to increased market volatility, the total risk amount has increased compared to the previous year. While the risk amount from guarantee contracts by securities firms is not large, if a securities firm fails to refinance and absorbs ABCP, the risk amount is set at 100%. The more ABCP absorbed, the higher the risk amount, causing the NCR to drop sharply.

If the NCR falls below 100%, liquidity problems in securities firms may intensify. Securities firms report NCR to the Financial Supervisory Service monthly, and if NCR falls below 100%, the FSS immediately recommends management improvements such as disposing of non-performing assets. If it falls below 50%, corrective measures such as mergers, business transfers, or management improvement orders are issued, which can cause funding problems and lead to profitable insolvency.

So far, securities firms' NCR ratios remain healthy. According to the Financial Supervisory Service, the average NCR of securities firms was 707.9% in the first quarter. As of the second quarter, NH Investment & Securities was at 2132%, Mirae Asset Securities at 1995.4%, Korea Investment & Securities at 1844.86%, and KB Securities at 1326.34%, with smaller firms having lower ratios. Daol Investment & Securities and Hanyang Securities had NCRs of 455.7% and 442.6%, respectively.

Experts believe that for ABCP refinancing suspension to lead to profitable insolvency, other liquidity shock events must occur simultaneously. In March 2020, the major market indices underlying equity-linked securities (ELS) dropped more than 10% in a day, causing large margin calls and liquidity shortages in securities firms' hedge positions, while ABCP refinancing was also suspended, creating liquidity issues on both fronts. However, no securities firms went bankrupt then. Large firms that sold large amounts of ELS received short-term loans from parent companies or the government, and smaller firms did not sell ELS. Since short-term funding markets account for only part of securities firms' overall funding, temporary liquidity support can resolve such issues.

However, there is a possibility that connected assets outside securities, such as savings banks, capital companies, and overseas subsidiaries, could become burdensome. Although not all exposures of savings banks or capital companies are deteriorated, they have expanded riskier positions than securities firms. Connected assets recognized as funds, investment associations, or overseas subsidiaries have limited publicly available information, making it difficult to know which underlying assets generated valuation gains over recent years. Researcher Jeong noted, "Large securities firms significantly contribute to asset size, profit scale, and even capital ratios through these connected assets. Particularly, Mirae Asset Securities and Korea Financial Group, which have large connected assets, pass supervisory standards with high consolidated NCR ratios despite low individual NCR ratios," adding, "This implies that if problems arise in connected assets, securities firms may find it difficult to absorb them with their own capabilities."

◆PF Suspension and Decline in Stock Market Trading Volume Inevitably Impact Securities Firms' Performance Next Year

Securities firms are expected to face tougher times next year than this year, with inevitable performance declines. Following the suspension of new PF, CP interest rates surged due to the Legoland incident, and ABCP refinancing issuance slowed, reducing IB fee income. NH Investment & Securities, Samsung Securities, and Meritz Securities, which announced third-quarter results, already reported quarterly IB fee income down about 20-30% year-on-year and quarter-on-quarter. Since new PF suspension is expected to continue throughout next year, annual IB performance is likely to be worse than this year.

Next year, equity investments appearing as collective investment securities and foreign currency securities (included in other items) may become obstacles. Due to the real estate market downturn, underperformance and loss recognition in this sector may become more pronounced. Until now, concerns have focused on real estate PF, but over time, worries about real estate equity investments are likely to increase.

Brokerage is expected to perform worse than this year due to further declines in trading volume and credit extension balances. Trading volume has been steadily decreasing since the start of interest rate hikes and the end of the bull market, and a trend reversal is unlikely until easing begins after tightening ends. Credit extension balances tend to move with the index; although the index has returned to pre-COVID-19 levels, credit is larger and interest rates are much higher than then, so further declines are expected. Meaningful rebounds in brokerage are anticipated only after liquidity expansion resumes following monetary policy easing.

Meanwhile, the securities industry expresses frustration. Although credit risk and liquidity risk differ, worsening investor sentiment is amplifying risks. A securities firm official said, "It is true that securities firms are experiencing liquidity crises, but the market is gripped by excessive concerns," cautioning, "It is only a short-term liquidity issue; the fundamentals of the securities industry itself have not been damaged." The Korea Financial Investment Association also stated that while securities firms' financial soundness is solid, liquidity crises have occurred because ABCP is not circulating at all, and excessive risk deductions on amounts absorbed from real estate PF exist, which is why they requested temporary easing of NCR regulations.

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