As the interest rates of South Korean bonds have increased more than 20 percent over the past month, domestic securities companies which own 212 trillion won (US$176.37 billion) worth of bonds are on alert. A rise in bond interest rates means a fall in bond prices. Therefore, the financial soundness of securities companies can get worse if bond prices keep falling, increasing their losses from bond investment.
Expectations for the trade negotiations between the United States and China have weakened investors’ preference for risk-free assets. Accordingly, there are growing concerns about huge losses from domestic public offering bond-type funds, which have grown by over 10 trillion won (US$8.32 billion) in size from the beginning of this year.
The interest rates on South Korea’s three-year and 10-year treasury bonds closed at 1.303 percent and 1.497 percent, respectively, on Oct. 2. The figures increased 19.2 percent and 27.7 percent, respectively, from the year’s lows, 1.093 percent for the three-year bonds on Aug. 19 and 1.172 percent for the 10-year bonds on Aug. 16.
Experts said in October that the bond market would have lower expectations than the previous month due to growing uncertainty from the additional interest rate reduction by Federal Reserve System (FED). In fact, the bond market survey index (BMSI) stood at 116.0 and the bond market psychology related to interest rates had weakened in October compared to the previous month, according to the results of a survey of 200 bond experts in South Korea conducted by Korea Financial Investment Association (KOFIA).
As the interest rate on bonds which completed a rally is expected to show an upward trend for a while, financial companies, including domestic securities companies, are likely to see losses on valuation on their bonds increase.
Chung Tae-joon, an analyst from Yuanta Securities, said, “With the rebound of interbank rates, securities firms’ gains on valuation of bonds have dropped.” The interest rates on both the three-year and the 10-year treasury bonds rose 10 basis points last month alone. He also said, “Interest rates will continue to rise because of the slowdown in demand for super long-term bonds from life insurance companies and the lower possibility of further reductions in the benchmark interest rate after October.”
As of the end of June, securities companies held 212 trillion won (US$176.37 billion) worth of bonds, accounting for 43.2 percent of the total assets. Large securities firms which have asset management books worth more than 10 trillion won (US$8.32 billion) are even more tense. They cannot avoid posting heavier losses than banks and insurance companies because they have, unlike banks and insurers, have a higher proportion of short-term bonds. This is in contrast with them making up the losses from the stock market crash in the first half of this year with gains from the bullish bond market.
The total contract amount of domestic bond-type funds currently comes to 33.69 trillion won (US$28.06 billion),according to Seoul-based financial data provider FnGuide. The figure increased 10.91 trillion won (US$9.09 billion) from the beginning of this year alone. The industry express concerns that the size of bond-type funds has grown as a large amount of money flooded into the bond market with a greater variability in the stock market. Bond-type funds, which has shown the downward trend in prices over the past month, have recorded a loss ratio of 0.28 percent. In contrast, domestic equity funds have posted 7.73 percent in profits over the same period.