Lotte Insurance has ultimately postponed its plan for early redemption of subordinated bonds (call option) amid opposition from financial authorities, leaving bond market investors in dismay. Experts emphasized that while call options have become customary for subordinated bonds and capital securities, they are not obligatory, and investors should exercise caution.
According to the Korea Exchange on the 13th, the price of "Lotte Insurance 8 (subordinated)" was traded at 9,890 won, down 89.5 won from the previous day in the on-market bond market on the 12th. It even fell to 9,600 won at one point. The price of this bond plummeted from 10,118 won on the 2nd to 9,920 won on the 7th, rebounded to 9,959 won on the 8th, and then fell again to 9,898.5 won on the 9th. Given the characteristics of bonds with small price fluctuations, the drop is considered significant.
A price in the 9,600 won range would indicate that if Lotte Insurance exercises the call option in the second half of the year, the annualized yield would exceed 10%. In other words, the current price reflects concerns that Lotte Insurance may not be able to repay subordinated bonds in the second half of the year.
Other subordinated bonds from Lotte Insurance are similar. For example, the price of the "Lotte Insurance 9 (subordinated)" bond, valued at 140 billion won, fell by 1.8% based on the closing price on the 7th and has continued to decline since then. The price of this subordinated bond has dropped by 3.1% within five trading days.
Lotte Insurance engaged in a sharp conflict with the Financial Supervisory Service (FSS) regarding the exercise of a call option on a subordinated bond valued at 90 billion won. The FSS intervened on the 7th, just before Lotte Insurance's call option exercise, citing concerns over soundness. However, Lotte Insurance also emphasized investor protection and financial market stability, asserting its intention to proceed with exercising the call option. As a result, the FSS brought out its sanctions card, and eventually, Lotte Insurance conceded on the 12th.
In the bond market, capital securities like subordinated bonds or new-style capital securities are typically exercised at a specified time regardless of maturity as a "practice." For subordinated bonds, a 10-year maturity is usually subject to a 5-year call option condition. Thus, it is not an exaggeration to say that most investors consider the actual maturity to be five years after issuance, when the call option can first be exercised.
However, this time Lotte Insurance's unusual inability to exercise the call option has led to signs of "panic selling" due to fears that subordinated bonds from other series and even other financial institutions may not be redeemed on time. Particularly, the subordinated bonds from Lotte Insurance, which has a credit rating of A-, were circulated more among individual investors than institutional investors. It is reported that individual investors hold about two-thirds of the 90 billion won for the 8th series subordinated bonds.
An industry official noted, "Subordinated bonds can provide interest yields about 1-2 percentage points higher than senior bonds as a reward for taking high risks, making them increasingly popular in recent times due to declining interest rates." He added, "Among these, subordinated bonds issued by insurance companies have attracted individual investors' attention due to their higher credit ratings for managing the solvency ratio (K-ICS)."
The industry pointed out that this incident should serve as an opportunity to improve the issuance system and practices of capital securities. While refinancing and exercising call options usually occur without difficulties, problems can arise in the financing environment like the LEGOLAND incident or if management conditions worsen at individual financial institutions as seen in the Lotte Insurance incident.
Kim Sang-man, a researcher at Hana Securities, commented, "This incident should prompt improvements in regulations and practices related to the issuance of capital debt securities other than cocos (contingent convertible bonds). If not, there's a high possibility that the so-called 'disguised capital controversy,' similar to ESG greenwashing, will continue in the future." He also mentioned, "From the investors' perspective, even if the options aren't exercised, they must remember that the bonds were originally issued that way. There is a reason for the high interest rates."
From the perspective of Lotte Insurance investors, what is crucial is whether Lotte Insurance can undertake a rights offering or refinancing to exercise its call option. However, due to the nature of the largest shareholder being a private equity fund that finds it difficult to inject additional capital, an immediate rights offering is likely to be challenging, according to industry analysis.