By Yoon Ja-young
Staff Reporter
While heavy household debt is weighing on the financial sector, a fresh concern is growing over the further deterioration in the quality of loans to construction firms.
Banks, mutual savings banks and insurance firms have actively extended loans in the form of project financing (PF) to builders. But the quality of these loans has been called into question as a growing number of small-to medium-size construction firms are going under after failing to service the PF loans amid slumping housing market.
PF is the financing of a long-term project, usually real estate development projects such as the building of apartments or a shopping center, in which the debt is paid back from the profit generated by the project. Hence, financial institutions give out loans if they determine that the project will be profitable.
This helps facilitate real estate development. Since it is based on the estimation of the future profitability, however, lenders may face difficulties if the real estate market enters a slump when the building is complete. Hence, when the developer seeks project financing, lenders usually request the builder of the project to guarantee payment.
The Financial Supervisory Commission (FSC) said that the absolute amount of PF loans is not large enough to threaten the soundness of the financial market. It said that the outstanding financing stood at 70 trillion won at the end of June at banks, savings banks and insurance firms, accounting for less than 5 percent of their total loans and 2 percent of their total assets.
``The amount is not that big. Its risks on the financial sector are not high,'' FSC spokesman Hong Yung-man told reporters. ``Also, any damage to investors in securities backed by project financing will not be big.''
The PF market has grown during the last few years. Of the balance of 70 trillion won, banks accounted for 31 trillion won; savings banks, 13 trillion won; and insurance firms, 4.2 trillion won, according to the FSC. PF asset-backed securities (ABS) and asset-backed commercial paper (ABCP) issuance accounted for 22 trillion won.
ABCP has been on the surge as the financial supervisor strengthened regulations on ABS. It is, however, more vulnerable to a credit crunch in the case of a market shock such as the U.S. subprime mortgage crisis.
Analysts fear that consecutive bankruptcies of mid-tier constructors could negatively affect the macro economy, which would in turn give a blow to the financial industry.
Dongbu Securities industry analyst Bae Jung-hyun said that banks could take the brunt of the PF woes even as they do not have much direct exposure to recent PF.
Its negative effect on the economy, however, will be a burden to the financial industry, according to Bae. ``Korean banks weren't directly exposed to the U.S. subprime mortgage crisis, but shares plunged on the fear that the macro economy may go bad following the U.S. economy hit by the issue. The mechanism holds true for project financing woes as well.''
Analysts are concerned that financial firms might cut down on their loans to builders, further aggravating contractors' finances and increasing default risks. It could trigger a vicious cycle where collapses of builders will further weaken the construction industry and result in a chain of defaults. Then it could develop into a Korean version of subprime turmoil.
For its part, the Korea Federation of Savings Banks (KFSB) said that its members have set aside enough funds to cover possible defaults on project financing.
``Our loan loss coverage is over 100 percent. At the same time, we have secured enough collateral. Therefore, we don't see much of a problem as of yet,'' a spokesman for the federation said.
What developers, constructors, and lenders haven't expected is the weak property market. Strict regulation on housing mortgages and tax policies cooled down the real estate market, and unsold new apartments are piling up around the country. While new apartments in popular metropolitan areas continue to draw investors, the number of unsold new apartments in the provinces increased by 11,000 in June from the previous month.
Builders only get a few million of won in a down payment for apartments in these places, but a considerable number of those who signed contracts are not paying afterward. Contractors who guaranteed the paying back of PF at the request of banks are on the verge of going bankrupt.
Korea Investment & Securities, for example, which financed an apartment construction project in Ulsan, got a notice from the project developer saying that it could not pay back the 35 billion won ABS loan. The securities firm requested Daeju Construction, the constructor of the project and guarantor of the PF, to pay it back instead. The incident degraded Daeju's credit ratings by three notches.
A number of mid-tier constructors based in provinces, including Shinil and Sejong, have declared bankruptcy or are on the verge of going bankrupt. According to the Bank of Korea, such mid-tier constructors recorded a 581 million won deficit in cash flow last year, despite 12.3 billion won in net profit.
The ensuing bankruptcies of constructors can put lenders at risk. ``An incident like Daeju Construction may make it even more difficult for construction companies to raise money. The risk can spread to non-banking institutions that bought the ABCPs,'' a spokesperson of a savings bank said.
Vice Finance and Economy Minister Lim Young-rok said that the government will take steps, if necessary, to keep PF problems from disrupting the market.
``We are closely monitoring the market. We will take appropriate steps, if necessary, (to stem) any problems arising from project financing securities.''