[Initial Insight] Hidden Borrowings Shaking the Body with the Tail

Increase in Real Estate PF Contingent Liabilities and Hybrid Capital Securities
Disclosure System Must Be Improved to Enhance Market Predictability

Hidden borrowings are causing trouble. These are borrowings that did not appear as loans or liabilities on the accounting books but suddenly need to be repaid or else lead to major problems. These concealed borrowings are not clearly visible in apparent figures. They also have the characteristic that the company does not have to bear direct financial burdens immediately. Because of this, companies use them as a means to increase leverage (debt) to hold maximum assets or conduct business with minimal capital. For example, special purpose companies (SPCs) engaged in business or overseas affiliates borrow business funds with guarantees provided.

A representative case is contingent liabilities from project financing (PF). When developers or SPCs with limited accumulated capital borrow business funds, relatively creditworthy construction companies and financial institutions participating in the PF project provide credit support to the developer. Besides debt guarantees, there are various types such as funding replenishment agreements and securitized bond purchase agreements. The term contingent liabilities comes from the fact that repayment responsibility may or may not arise depending on the situation. If the real estate market is favorable and the PF project proceeds as planned, there is no responsibility for the debt, but if the project faces difficulties and the developer becomes insolvent, the company that provided the guarantee must take responsibility. In other words, the hidden borrowings suddenly "pop up" and reveal themselves.

Another form of hidden borrowing is hybrid capital securities (perpetual bonds) issued by companies to lower their debt ratios. As the name suggests, perpetual bonds have maturities of over 30 years and are considered permanent, so they are not recorded as loans or liabilities in accounting. Therefore, companies that need funds but want to avoid worsening financial ratios such as debt ratios mainly issue these bonds. Unlike capital increases through paid-in capital, which require major shareholders to inject new capital or accept dilution of their shares by third-party funds, perpetual bonds do not carry such burdens. The company only needs to pay investors a small amount of interest.

However, in reality, perpetual bonds have a fairly strong repayment obligation. Most are redeemed 3 to 5 years after issuance. If the issuer does not exercise the early redemption right (call option) at the designated time to repay principal and interest, they face a penalty of sharply increased interest expenses. Also, if the call option is not exercised, the issuer loses credibility in the bond market, making additional fundraising difficult. Although maturity can theoretically be extended indefinitely, in practice, it is difficult to exceed 5 years.

When hidden borrowings suddenly surface, the shockwave to investors is considerable. The creditworthiness of the trusted company rapidly deteriorates, and the value of invested stocks and bonds plummets. If anxiety spreads that similar cases may increase, the entire financial market falls into a vicious cycle of turmoil. According to the Korea Capital Market Institute and others, the scale of real estate-related "shadow banking" such as real estate trusts, PF loan guarantees, and securitized bonds reached 876 trillion won as of the end of September last year. This corresponds to 42% of the country's gross domestic product (GDP). The outstanding balance of hybrid capital securities and CoCo bonds is also rapidly increasing. If problems arise, the tail can strongly shake the body and more.

Although the market is expanding infinitely and causing problems here and there, the level of disclosure regarding hidden borrowings is disappointing. Most disclosures are passive, merely listing contingent liabilities or actual borrowings. It is difficult to gauge the detailed terms of contracts or the level and scope of risks based solely on disclosure content. Transparency of information increases predictability for the market and helps prevent the spread of market anxiety. Efforts to establish a disclosure system commensurate with the market size appear urgently needed.

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