Financial Holding Companies Issue 'Coco Bonds' Amid PF Provision Burden

Shinhan Financial Issues 400 Billion Won
BNK Financial Also Issues 200 Billion Won
Capital Recognized Equivalent to Issuance Amount
Defending BIS Ratio Decline

Lee Bok-hyun, Governor of the Financial Supervisory Service. Photo by Heo Young-han younghan@

Shinhan Financial Group and BNK Financial Group are consecutively issuing contingent convertible bonds (CoCo Bonds) worth several hundred billion won. This move is to prepare for a potential decline in the holding companies' Basel III (BIS) capital adequacy ratios due to large-scale provisions accumulated by their affiliated financial companies from project financing (PF) defaults. Issuing CoCo Bonds allows the issuance amount to be recognized as capital, which helps improve the BIS ratio.

According to the investment banking (IB) industry on the 1st, Shinhan Financial Group issued CoCo Bonds worth 400 billion won with Kyobo Securities, Hanyang Securities, and DB Financial Investment as lead managers. The maturity is over 30 years and is perpetual, but there is a call option to redeem principal and interest after 5 years. If early redemption is not exercised and a penalty interest rate is paid, the maturity can be extended continuously. The bond issuance interest rate was set at 4.49%, which is 1.16% above the 5-year maturity government bond yield.

BNK Financial Group recently formed a syndicate of lead managers centered on securities firms to issue CoCo Bonds worth 200 billion won. Although the holding company’s board decided to issue CoCo Bonds worth 500 billion won in the first half of this year, considering interest rates and investment demand, only 200 billion won will be issued initially. The structure is almost identical to the CoCo Bonds issued by Shinhan Financial Group, but the issuance interest rate is expected to be somewhat higher, in the mid-to-high 4% range compared to Shinhan’s.

CoCo Bonds are bonds but have characteristics of capital. If the financial company agrees to pay penalty interest, it does not have to repay principal and interest continuously like capital. Due to this feature, financial holding companies and banks can include CoCo Bonds in accounting supplementary capital (AT1) when calculating the BIS ratio. They are similar to hybrid capital securities (perpetual bonds) in that they are bonds recognized as capital. However, if pre-set conditions are not met, CoCo Bonds are either written off or converted into common stock. The name CoCo Bond comes from the English initials of Contingent (when a certain situation occurs) and Convertible (converted into stock). In Korea, the financial supervisory authorities have decided that if a financial institution is designated as insolvent, the bonds will be automatically written off.

The reason financial holding companies are consecutively issuing CoCo Bonds is to defend against a decline in the BIS ratio. Large-scale provisions accumulated by affiliated financial companies due to PF defaults can negatively affect the holding companies’ BIS ratios.

Shinhan Financial Group is known to be in a situation where Shinhan Investment Corp. and Shinhan Capital must accumulate large-scale provisions for PF defaults. In particular, Shinhan Capital is considered the capital company with the highest proportion of real estate financing in its total assets. The ratio of loans overdue by less than three months and classified as watch or below has surged, and the PF-related default ratio increased sharply last year. In the case of BNK Financial Group, in addition to PF defaults by several affiliated financial companies, Kyongnam Bank must also set provisions due to a PF embezzlement incident. The scale of the embezzlement, initially reported to be around 50 billion won, was recently confirmed to be close to 300 billion won.

As the burden of PF provisions increases for financial companies, the issuance of CoCo Bonds by financial companies is expected to continue. An IB industry insider said, "As the burden of PF-related provisions grows, more financial companies are preparing to issue CoCo Bonds or perpetual bonds." The insider added, "CoCo Bonds issued by financial holding companies have high principal and interest repayment stability but offer high interest rates, making them popular among institutional and individual investors. Although the interest rate may rise somewhat due to increased supply if issuance volume surges, there should be no significant difficulty in securing investors."

Meanwhile, the Financial Supervisory Service has warned that it will hold financial companies accountable if they do not accumulate sufficient provisions to prepare for PF defaults. It ordered that bridge loans that have not been converted to main PF loans for a long time should be recognized as 100% expected loss and provisions accumulated accordingly; main PF loans with delayed construction or low pre-sale rates should have provisions set considering the worst-case scenario; and if the land value used as collateral declines, the loss should be recognized as an evaluation loss.

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