[Editorial] Project financing debacle

South Korea’s financial regulators remain jittery about growing risks linked to real estate project financing loans. No wonder, then, that financial officials have been actively issuing more warnings with more details.

One notable change is that their warnings are now coming with more explicit expressions. For instance, Lee Bok-hyun, governor of the Financial Supervisory Service, called real estate PF risks a “detonator” hooked up to the Korean economy at a press conference held Monday.

In outlining the FSS’ major projects for 2024, Lee said the top financial regulator would strive to persuade financial companies to address credit risks from real estate project PF loans.

“Beginning this year, we will even consider putting out of the market any firm that makes poor decisions, such as delaying the recognition of legitimate losses, or avoid its responsibilities as a financial institution,” Lee said.

Lee said the regulators, which had been relatively lenient in slapping penalties for negligent behaviors, will spearhead restructuring for real estate PF loans, close to market principles, defying any possible resistance related to interrelated interests among market players.

It is hard to predict at this point whether Lee’s threat will actually lead to the highest-level punitive action against a financial firm. What’s certain, though, is that the potential crisis stemming from real estate PF loans cannot be ignored any longer, and regulators view the issue as serious enough to prod financial companies to absorb and write off related losses.

The problem of real estate PF loans was widely exposed in December last year when ailing builder Taeyoung Engineering & Construction applied for a debt-restructuring program to battle a cash crunch.

The 16th-largest builder in Korea was struggling with a liquidity shortage stemming from real estate PF loans, exacerbated by a slump in the property market. The troubles with Taeyong also sparked worries about negative impact on other builders as well as related financial firms.

As of September last year, outstanding loans extended to the construction and property sectors amounted to a record 608.5 trillion won, up 22.3 percent from the amount seen in 2021, according to the FSS. The delinquency rates for construction and real estate loans in non-banking sectors reached all-time highs of 5.51 percent and 3.99 percent, respectively.

The country’s total PF loans were estimated at 134.3 trillion won in end-September, while their delinquency rate jumped to 2.42 percent, up from 1.19 percent at the end of 2022.

Banks and other top-tier financial companies are in a better position. Particularly vulnerable are second-tier non-bank lenders and securities firms exposed to higher risks of a cash shortage. Korea Investors Service data shows that high-risk real estate debt-to-equity ratios for mid-sized and small companies was 43.3 percent and 34 percent as of September last year, compared with 29.2 percent for their larger peers.

The FSS and other financial regulators are fully aware that the bulk of PF loans handled by small firms are set to mature this year, which will inevitably lead to major losses.

Reflecting the sluggish property market, 19 construction companies went bankrupt last year. Credit rating agencies are also rushing to downgrade the credit outlook of some construction firms.

Other government agencies related to finance are also monitoring developments over real estate PF loans. Last month, First Vice Finance Minister Kim Byoung-hwan stressed concerns over corporate insolvency risks, pledging to provide the necessary liquidity for restructuring and asking companies to help pull off a soft landing.

The outlook, meanwhile, is far from optimistic. The domestic construction market shows no sign of a recovery. Construction firms also complain about rising material costs, which make it even harder to secure short-term loans to tide over a cash shortage. Financial regulators, having acknowledged the heightened risks of real estate PF loans, must take more aggressive and timely measures to help cash-strapped firms to avoid hitting the much-dreaded “detonator.”