In a bind, companies look to perpetual bonds

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In a bind, companies look to perpetual bonds

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The business community has been making a lot of noise about perpetual bonds recently.

At issue is whether the new type of bond is considered capital or debt when a company issues it to finance funds.

The debate began after Doosan Infracore, a heavy industry equipment branch of Doosan Group, issued 500 million won ($457,749) worth of perpetual bonds for the first time as a local company last month.

A perpetual bond is a bond with no maturity date. Perpetual bonds pay coupons forever, and the issuer does not have to redeem them. Therefore, it is deemed a useful way for companies to generate capital while lowering their debt-to-capital ratio.

Being saddled with mounting debt amid the protracted global economic recession, companies in the heavy industrial field - those particularly in need of huge investments before a profit can be made - are increasingly showing interest in the bonds.

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At the request of the Financial Services Commission (FSC), the Korea Accounting Standards Board began deliberation to define the bond last week.

But the board failed to come to a conclusion, since marked differences remained among experts, and decided to extend the deliberation period by two to three weeks.

Doosan financed 500 million won by issuing the bonds with a 3.328 percent interest rate through the Korea Development Bank.

Under the terms of the contract, Doosan’s bonds are also called hybrid bonds, categorized as between perpetual and non-perpetual bonds, since the bonds have a minimum 30-year maturity period. After five years, the issuer gets a call option, while the investor can claim a put option. The interest rate rises to 5 percent after five years.

With the call option, the buyer can purchase an agreed quantity of a particular commodity or financial instrument from the seller of the option. With the put option, the buyer has the right to sell the asset at the strike price by the future date.

“We are just waiting for the board’s conclusion,” said an executive surnamed Choi at Doosan Group. “It’s only the matter of accounting, and we have already financed the fund on advice of financial experts.

“Doosan Infracore’s fiscal health isn’t faring badly,” he added.

The company’s total capital stands at 2.56 trillion won as of June this year, while the total debt is at 9.7 trillion won, according to data reported to the Financial Supervisory Service (FSS).

After the company took over U.S.-based equipment manufacturer Bobcat for $5.1 billion in 2007, it has been suffering rumors of a possible liquidity crunch.

The FSC, the country’s financial watchdog, claims that perpetual bonds should be deemed as debt.

“There are risks that troubled companies might use the bond to make themselves look financially healthy,” said an FSC official. “Under the terms, since Doosan would face the call option right after five years, it is closer to debt.”

There needs to be established standards for such new types of bonds, he added.

A researcher at Korea Capital Market Institute said in his report that there are a few limits in seeing Doosan’s hybrid bonds as capital.

“If the issuer doesn’t exercise the call option, the interest rate of the bond goes up, adding more burden on Doosan to pay the interest,” researcher Kim Pil-kyu said. “After five years, there is a high possibility that the issuer will demand early redemption under the terms of the contract, making the bonds more like debt than capital.”

KDB, the overseer of Doosan’s bonds, released an official statement early this month, saying that it is perplexed at the ongoing debate about the characteristics of perpetual bonds.

“Based on the International Financial Reporting Standards, perpetual bonds are deemed as capital,” the bank said in the statement. “We ask for the government’s support for businesses that are struggling to survive in the midst of the global economic crisis.”

According to the financial sector, KDB Chairman, as well as the country’s former finance minister, Kang Man-soo was particularly interested in helping Doosan issue the bonds.

“Some say that Kang had special interests in the Doosan case, because he believed companies are facing even a tougher crisis than the 2008 crisis, and as a state-run bank, KDB should take responsibility in supporting them,” said an analyst at a foreign-based investment bank on the condition of anonymity.

As Doosan’s bond issuance has become a topic for debate, three other companies that have been preparing to issue similar bonds are facing concerns.

According to the industry, Korean Air, Hanjin Shipping and Hyundai Merchant Marine are planning to issue 300 to 500 million won worth of perpetual bonds within the year.

Korean Air has accrued 20.3 trillion won in debt as of the first half of the year. Its debt ratio on a consolidated basis is almost at 830 percent. The company’s total capital, including cash, stands at 2.45 trillion won, according to the FSS data.

“If perpetual bonds are not considered capital by the board, it is less likely that Korean Air will continue its plan,” said a financial analyst at Woori Investment & Securities.

The country’s No. 1 airline is in urgent need of the bonds in order to acquire the state-owned Korea Aerospace Industries in competition with Hyundai Heavy Industries. Formal bidding is scheduled for Nov. 30. It also has a plan to purchase 28 new flights by 2014.

By Song Su-hyun [ssh@joongang.co.kr]

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