S&P Global Ratings' equity content assessment of hybrid capital instruments issued by rated Korean banks and insurers remains unchanged. In early November, midsize insurer Heungkuk Life Insurance Co. Ltd. (unrated) reversed a hybrid noncall decision. This has raised some questions about Korean bank and insurance hybrid issuers' ability to manage the timing of refinancing by choosing not to call at optional call dates.

We think it's premature to assume from Heungkuk's actions that Korean bank and insurance hybrid issuers do not have sufficient flexibility to choose not to call their hybrids. Accordingly, we are maintaining the current equity content classifications on hybrids issued by rated banks and insurers. We expect that Korean regulators will continue to encourage and oversee prudent capital management by regulated entities.

In our view, the regulatory approval of Heungkuk's call decision was mainly based on its ability to rebuild solvency and expectation to contain the effect on the secondary market pricing of Korean hybrids. We therefore see the response to the Heungkuk case as idiosyncratic and not indicative of a shift in the regulators' capital-management approach. However, we will continue to monitor developments in the Korean hybrid market, as we expect that banks and insurers should retain the flexibility to manage refinancing dates or needs by choosing not to exercise optional calls in various market stresses.

We believe it typically makes sense for an issuer not to call a hybrid when the refinancing cost is significantly higher or if the issuer would not be able to issue a replacement instrument. While we recognize that there can be immediate negative reputational or pricing effects from a noncall, such a decision should be a realistic option for an issuer that is under pressure or is in a market that faces heightened funding pressures.

If issuers typically have to call a hybrid because of market expectations, despite not being able to refinance or only being able to do so at a significantly more expensive cost, then we cannot be confident that the hybrids will be available on the issuer's balance sheet to help absorb losses or conserve cash when needed. In those cases, the call dates would be tantamount to maturity dates, which would make the hybrids too short-term to be treated like equity in our credit analysis.

Heungkuk's US$500 million hybrid bond prices fell substantially following the initial noncall announcement, which spread to other Korean banks and insurers' hybrids in general. (There hadn't been a hybrid noncall in this market since Woori Bank decided not to call a Tier 2 hybrid in February 2009.)

It seems that the secondary market pricing effect fed through to the insurer's business operations, with media reports citing an increase in insurance policy cancellations. This happened amid a broader weakening of investor sentiment in the domestic market due to unusual factors that include a highly rated government-related entity's substantial operating losses and heavy bond issues, the default of asset-backed commercial paper guaranteed by a local government, a weak property market, and a rapid increase in domestic interest rates. The Bank of Korea raised the policy rate to 3.25% from 1.0% at year-end 2021 to curb inflationary pressures. Market confidence was therefore generally more fragile.

We believe the financial regulators were supportive of Heungkuk's call decision--even though they had previously been supportive of the decision not to call--because doing so would contain the significant adverse secondary pricing impact on Korean hybrids. We believe Heungkuk is committed to boosting its regulatory solvency ratio to above 150%, which was a contractual condition for it to be able to exercise the call option on the hybrids subject to regulatory approval. Heungkuk's regulatory solvency ratio was 154.4% at the end of September 2022. The contractual features required an issuer with a solvency ratio below 150% to replace the hybrid prior to redemption, which Heungkuk would not have been able to do in existing market conditions. However, we believe that Heungkuk received regulatory approval to not replace the hybrid prior to the redemption due to a prospective view of the insurer's solvency ratio.

According to media reports, the insurer financed the call through short-term repurchase agreement transactions from Korean banks and plans to receive an equity injection from affiliates. In our view, this means that the capital position of the issuer is currently weaker than it was prior to the call. We expect that the regulator allowed this because Heungkuk will likely build its solvency position partly through the support of its affiliates, and because of the availability of collateralized funding. We expect the regulators to continue to support prudent regulatory capital management by the local banks and insurers.

Our current assessment of equity content on rated Korean banks and insurers' hybrids assumes that a noncall remains a viable option for them to exercise flexibly to manage their capital and the timing of any refinancing. In the future, we expect hybrid investors to be more explicit about building a noncall premium into their pricing, as they do for some bank hybrids. We anticipate this will lead to higher funding costs for banks and insurers' new hybrid issues but, because investors will be pricing in this risk more explicitly, making it less challenging for the issuer to choose not to call when refinancing is too costly or not feasible.

We will continue to monitor market developments to assess whether future events affect the flexibility of Korean banks and insurers to manage hybrid call decisions. This could result in a review of the hybrids' equity content.

Related Criteria

• Hybrid Capital: Methodology And Assumptions, March 2, 2022

Related Research

• Credit Implications Of Hybrid Noncall Decisions, Nov 24, 2022
• Australian Regulator's Reminder On Hybrids Should Be No Surprise, Nov. 8, 2022