Companies Turn to Hybrid Securities Amid Financial Woes

Korean companies, grappling with prolonged industry slumps in sectors such as construction, chemicals, and retail, are increasingly turning to hybrid securities, also known as 'new hybrid capital instruments,' as a means to shore up their finances. These instruments, once the exclusive domain of financial firms, are now being adopted by a wider range of corporations seeking to bolster their capital.

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The issuance of hybrid securities, which are subordinated bonds, is classified as 'capital' but has debt-like characteristics due to high issuance costs and the issuer's pressure to exercise the call option due to the step-up clause, thus creating an illusion that the issuer's financial indicators such as debt-to-equity ratio and equity ratio are more favorable than they actually are.

The shift is partly driven by recent amendments to the Commercial Act, which have made rights offerings, a traditional method of capital raising, more susceptible to criticism regarding potential dilution of shareholder value. Hybrid securities offer a more palatable alternative, allowing companies to expand their capital base with less controversy.

According to Korea Investors Service, general corporations (excluding financial and public enterprises) have issued approximately 17.5 trillion won in hybrid securities with call options between 2021 and 2025. The issuance volume saw a significant jump from 1-2 trillion won annually in 2021-2023 to 6.6 trillion won in 2024 and is projected to reach 6.2 trillion won in 2025. This surge means that general corporations now account for 29% of the total domestic hybrid securities issuance (61 trillion won) during this period.

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Some companies, excluding hybrid securities, are in a state of complete capital erosion, and the issuance of hybrid securities may hide a weakening of actual financial capacity.

While these securities are attractive for their accounting treatment as 'equity capital,' they possess debt-like characteristics, including a maturity of over 30 years and a 'step-up' clause that increases interest rates if the call option is not exercised after five years. This can create a misleading impression of financial health, as noted by Korea Investors Service, which warned that these instruments can 'induce an illusion of financial indicators such as debt-to-equity ratio and equity ratio being more favorable than they actually are.' Some companies in the construction, chemical, and media sectors now have hybrid securities exceeding 100% of their equity capital, raising further concerns about their true financial resilience.

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With the amendment to the Commercial Act, the procedural legitimacy and disclosure obligations for rights offerings have been strengthened compared to before. Hybrid securities are emerging as a strategic financing alternative for companies.