[Edaily Marketin KIM YEON-SEO Reporter] Issuance of mezzanine securities, such as convertible bonds (CBs), surged by 70% compared to last year. As rising corporate bond yields have increased financing costs, mezzanine securities have emerged as an alternative funding source for companies. However, some point out that if stock conversions do not occur due to falling stock prices, the repayment burden will remain, potentially increasing liquidity risks for companies.

According to BondWeb on the 18th, the cumulative issuance of mezzanine securities from the start of this year through that day totaled 8.6492 trillion won, an increase of 3.5545 trillion won (69.8%) compared to the 5.0947 trillion won issued during the same period last year.

Mezzanine securities are financial products that combine characteristics of both bonds and stocks, including convertible bonds (CBs), bonds with warrants (BWs), and exchangeable bonds (EBs). Investors earn interest income and can also expect additional returns through stock conversion or exchange if stock prices rise.

CBs are driving the expansion of the mezzanine market this year. From the start of the year through today, the issuance volume of CBs has reached 7.3502 trillion won, an increase of approximately 2.6 times (155%) compared to the 2.8772 trillion won recorded during the same period last year. This figure has already surpassed last year’s total annual issuance volume of 5.7029 trillion won.

The issuance volume of BW has also surged from 32.5 billion won during the same period last year to 333.3 billion won this year. In contrast, EB issuance has declined from 2.185 trillion won to 965.7 billion won. The significant increase in EB issuance last year is believed to have been influenced by preemptive issuances by companies prior to the amendment of the Commercial Act. Last year’s annual issuance volume was 224.9 billion won for BW and 4.8043 trillion won for EB.

Shift to Mezzanine Due to Corporate Bond Interest Rate Burden

The sharp rise in mezzanine issuance is attributed to deteriorating conditions for corporate bond issuance. As rising corporate bond interest rates have increased funding costs, companies facing unfavorable business conditions or with low credit ratings are actively seeking alternative funding sources such as short-term financing, asset securitization, and mezzanine financing.

In particular, convertible bonds (CBs) can be issued at a lower coupon rate than regular corporate bonds in exchange for granting investors the right to convert them into equity. Even companies with low credit ratings that struggle to access the public corporate bond market can secure investor demand based on the potential for rising stock prices. Another advantage is that if stock prices rise and the bonds are converted into equity, the principal does not need to be repaid in cash; instead, debt is converted into equity, thereby lowering the debt-to-equity ratio.

Since convertible bonds are often issued privately, companies can raise working capital or refinancing funds more quickly and flexibly than with public corporate bonds. Analysts attribute the growing demand for convertible bonds to the fact that investors can secure interest income from the bonds while also expecting conversion gains from rising stock prices.

"Burden of Put Options and Refinancing When Stock Prices Fall"

However, if a sharp drop in the stock price causes it to fall below the conversion price, investors’ incentive to convert the bonds into shares diminishes, leaving the principal amount of the CB as a debt on the company’s balance sheet. If investors exercise their early redemption right (put option), the company must repay the principal before the original maturity date, which can increase the company’s short-term liquidity burden.

Companies short on cash may also resort to refinancing by issuing new convertible bonds to redeem existing ones. If the conversion price is repeatedly lowered through refixing, the number of shares to be issued in the future will increase, potentially diluting the equity value of existing shareholders. There is also a possibility that an increase in potential selling pressure could constrain a stock price recovery, leading to a vicious cycle that further exacerbates the burden of refixing and refinancing.

A bond market official stated, “Amid recent increased volatility in the stock market, there is a possibility that investment demand for convertible bonds will expand in anticipation of a future stock price rebound,” adding, “However, if stock prices remain below the conversion price when the put option exercise date arrives, the number of investors demanding principal repayment instead of stock conversion may increase; therefore, both the issuing company’s liquidity and its refinancing capacity must be carefully examined.”

"Growth-oriented or financial defense-oriented… the purpose of fundraising must be examined"

The securities industry views the impact

of mezzanine debt

on corporate creditworthiness as varying not only based on the structure of individual products but also on the intended use of the raised funds.

Given that expectations of rising stock prices and equity conversion are driving investment demand—as evidenced by the recent increase in convertible bond (CB) issuances with 0% coupon rates—analysts suggest that credit investors should determine whether the raised funds are “growth-oriented” for business expansion or “financial defense-oriented” for securing liquidity.

Lee Se-hyun, an analyst at NH Investment & Securities, explained, “Korea Aerospace Industries and Hyundai Engineering & Construction, which issued convertible bonds this year, are examples of companies with access to the corporate bond market that raised funds for growth purposes,” adding, “They secured investment demand based on growth expectations in the defense and nuclear power industries, respectively.”

He continued, “Although convertible bonds are recognized as debt at the time of issuance, the leverage ratio can improve if they are converted into equity in the future,” and noted, “If the coupon rate is set at 0% based on expectations of a rising stock price, the issuer can also benefit from reduced interest expenses.”

On the other hand, it has been pointed out that if a company with limited access to the corporate bond market issues convertible bonds to secure working capital or repay existing debt, its repayment capacity must be scrutinized even more closely.

The analyst noted, “Small and medium-sized enterprises issuing CBs for financial defense purposes should focus on repayment potential rather than conversion potential,” and cautioned, “They must be mindful that the company’s liquidity risk could increase if refixing and refinancing occur repeatedly or if the burden of repaying put options becomes significant.”