‘Breach of Financial Covenants’ Lotte Chemical Faces Multiple Funding Challenges Including Acquisition Financing Maturity

Lotte Chemical has been found to be in violation of financial covenants agreed upon with financial institutions due to deteriorating performance and financial conditions. This is expected to be a negative factor for future fundraising, along with the possibility of a credit rating downgrade. Meanwhile, there are numerous financing challenges, including the need to refinance acquisition financing borrowed for the acquisition of Lotte Energy Materials (formerly Iljin Materials).

The scene of Lotte Chemical's 'CEO Investor Day' event held last July
[Photo by Lotte Chemical]

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According to the investment banking (IB) industry on the 19th, Lotte Chemical failed to maintain certain financial ratios promised when borrowing funds from banks and securities firms in the past. When borrowing funds from the Japanese Mizuho Bank, it agreed to maintain a consolidated 'net financial debt/EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization)' ratio of 4 times or less and an 'EBITDA/interest expense' ratio of 5 times or more. It also entered into financial covenants to maintain the same ratios with the lending group when borrowing acquisition funds for Lotte Energy Materials (formerly Iljin Materials).

However, according to the recently disclosed first half financial statements, Lotte Chemical failed to meet the promised financial ratios. Until 2020, Lotte Chemical maintained a net cash position with more cash than borrowings, based on substantial cash-generating ability. Despite a rapid increase in borrowings due to years of performance deterioration and expanded investments, the debt ratio still remains below 100% thanks to long-term capital accumulation. However, due to a sharp decline in EBITDA and increased interest expenses caused by worsening performance, the 'EBITDA/interest expense' ratio fell below 5 times.

Fortunately, financial institutions that lent money have not imposed sanctions such as repayment demands or collateral restrictions despite the covenant violations. Mizuho Bank, known to have lent the most funds to Lotte Chemical, issued a waiver (WAIVER, contract maintenance agreement) to Lotte Chemical. The financial covenants related to Lotte Energy acquisition financing are stated not to apply as of this half-year period.

A financial institution official explained, "If sanctions such as immediate repayment demands are imposed on some borrowings with financial covenants, all existing loans could become non-performing," adding, "From the perspective of financial institutions that have lent trillions of won, waivers are often granted to maintain business relationships with the large corporation and ensure stable repayment of the entire loan portfolio."

Lotte Chemical Daesan Plant
[Photo by Lotte Chemical]

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However, there are expectations that failing to meet financial covenants alone will negatively impact future fundraising. Although Lotte Chemical received a waiver, it classified a 300 billion won loan as a current liability rather than long-term debt. This means it lost the right of grace period (the right to extend the loan maturity by more than 12 months) due to covenant breach. According to accounting standards, borrowings in breach of covenants must be classified as current liabilities.

There is also uncertainty regarding credit ratings. Credit rating agencies assessed Lotte Chemical’s credit rating (AA0) outlook as 'negative' in the first half of the year. With cumulative losses recorded in the first half, the possibility of a downgrade to AA- has increased.

The need for fundraising has grown. Although it held 4.5 trillion won in cash equivalents at the end of Q1, borrowings have exceeded 10 trillion won. Short-term borrowings and current portions of long-term debt (long-term borrowings due within one year) have surpassed 5.5 trillion won. Even if investments are reduced, external financing is inevitable considering necessary ongoing investments and operating funds.

Lotte Chemical must also address the March maturity of 700 billion won acquisition financing for Lotte Energy Materials next year. It is reportedly exploring various options with securities firms, including commercial paper (CP), corporate bonds, and price return swaps (PRS). Recently, it secured operating funds of 30 to 40 billion won by signing a purchase agreement credit card contract with Lotte Card.

An IB industry official diagnosed, "Lotte Chemical has a large cash holding and its debt ratio is not yet high, so there should be no major difficulties in securing funds," but added, "Negative factors such as covenant breaches, credit deterioration, and worsening industry conditions are overlapping, so investors are likely to take a conservative stance."

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