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His predecessor signed up last year for the currency option called "knock-in knock-out,” or KIKO, a derivatives product to hedge against the local currency's rise against the U.S. dollar. But the derivatives have become liabilities due to the unexpected depreciation of the won amid the recent global financial turmoil.
Lee’s predecessor was one of many chief financial officers here, mostly from small- and medium-sized exporters, sacked or punished for the wrong-way bets on the local currency.
The KIKO currency option, popular among exporters, enables companies to sell dollars at a fixed won-dollar rate if the won moves within a certain range set by the contact. But if the won falls below the band, companies are forced to sell dollars below the market rate, incurring heavy losses.
Mainly due to losses from the contracts, PSM Inc. swung to a net loss in the third quarter despite a 49 percent rise in sales and a 35 percent gain in operation profits.
The company’s shares tumbled over 57 percent for the past three months. "Losses from currency-related hedging mainly contributed to a big dent in its earnings," said Choi Ji-hwan, an analyst at NH Investment & Securities.
But PSM Inc.'s condition is much better than that of Taesan LCD Co., a flat-screen parts maker with annual sales of 700 billion won (US$484 million), which collapsed and filed for bankruptcy due to mounting losses from the KIKO currency option contract.
Taesan LCD said its net loss in the third quarter alone reached 644.7 billion won, compared with 6.5 billion won in net losses for the whole of 2007. The company posted 609.2 billion won in losses from KIKO options. It earned 11.1 billion won in net profit in 2006 and 16.3 billion in 2005.
According to the Korea Federation of Small and Medium Business, most of the 520 companies who bought KIKOs are on the verge of insolvency. The exact amount of combined losses at the firms has yet to be determined.
The losses from the derivatives product have spilled into local lenders already hit by the global credit squeeze and economic downturn.
In particular, the country's fourth-ranked Hana Financial Group swung to an unprecedented loss in the third quarter due to heavy costs from Taesan LCD, which has been in the bank's debt-restructuring program. Hana has set aside 250.7 billion won against its exposure to Taesan LCD for the third quarter. Other banks are also exposed to KIKO-related losses.
Financial regulators warn that losses from KIKO options would further grow in the fourth quarter because the local currency still remains weak against the greenback.
"More and more companies could collapse in the first half of next year, largely due to heavy losses from KIKO options, unless the local currency turns stronger and there are cash injections," said Kim Tae-hwan, an official at the Korea Federation of Small and Medium Business.
About 100 small companies suffering big losses from currency hedging derivatives have recently filed a class-action suit against 13 local banks that sold them the KIKO products, insisting the options were sold without an explanation of the risks.
The companies are seeking nullification of the KIKO contracts and compensation from banks. The names of the banks were not disclosed. "We demand that the banks return the principal and interest by terminating the contract," they said in a joint statement.
Still worse, the companies are suffering from the liquidity squeeze as local banks are tightening up their credit standards because of funding shortages caused by the global financial rout.
"We have managed to secure liquidity enough to avoid bankruptcy, but many other companies are still striving to win cash," said Lee of PSM Inc.
To help ease their cash crunch, the government plans to expand the supply of liquidity to small firms. "A state-run credit guarantee agency plans to provide about 3 trillion won worth of liquidity to the corporate bond markets," the financial watchdog said in a statement.
“The government will also invest a combined 2.65 trillion won in state-run banks in a bid to increase their lending capacity,” it said.
The government has already extended 289 billion won in liquidity to 145 smaller companies in recent weeks through commercial lenders, by extending new loans or rolling over existing debt.
