Capital Companies' Bright First Half... Issues with PF Loans Begin Now

[Asia Economy Reporter Yu Je-hoon] Bank-affiliated capital companies have continued strong growth in the first half of this year. However, concerns are growing that "the problem starts now," as the impact of the base interest rate hikes is expected to intensify from the second half, and the deterioration of the real estate project financing (PF) sector, which has recently increased its share significantly, is accelerating.

According to the financial sector on the 1st, the net income of capital companies under the four major domestic financial holding companies (KB, Shinhan, Hana, Woori) increased by 30-50% compared to the same period last year in the first half of this year. Woori Financial Capital recorded 124.9 billion KRW, up 55.4%, Shinhan Capital posted 203.6 billion KRW, up 55.1%, while KB Capital and Hana Capital also showed relatively solid growth of 38.1% and 30.0%, respectively.

Other bank-affiliated capital companies also showed favorable performance. BNK Capital showed a high growth rate with 118.7 billion KRW, up 66.2%, and ▲DGB Capital (18.3%) ▲NH Nonghyup Capital (6.2%) ▲JB Woori Capital (1.3%) also continued their growth. However, IBK Capital under Industrial Bank of Korea recorded an 8.9% decline.

The industry explains that these strong performances of capital companies are the result of improvements in the corporate finance sector, which has been intensively nurtured, as well as the fact that funds were raised at low interest rates. According to Korea Credit Rating, in the first quarter, 32 domestic capital companies showed little change in existing operating yields, but due to the low cost of funds, operating profit margins reached 3.3%.

The problem will become visible from the second half, when the impact of interest rate hikes takes effect. The industry expects the impact of rising funding costs to fully materialize from the second half. If businesses have been operating with funds raised at low interest rates until early this year, they now face burdensome interest levels. As of the 28th, the interest rate on 3-year AA- rated financial bonds was 4.561%, up about 200 basis points (1bp=0.01%) from 2.634% at the beginning of the year, and nearly 300 basis points compared to last year. Due to this impact, even top-tier credit card companies are reportedly feeling the burden of bond issuance.

In particular, the rise in funding costs is expected to continue, increasing industry concerns. The Bank of Korea, which raised the base interest rate by 125 basis points to 2.25% this year, described the market's expectation that the year-end base rate will be 2.75-3.00% as a "reasonable expectation." Considering that most of the capital industry's core business, automobile finance, is composed of fixed interest rates, a decline in profitability is inevitable.

Corporate finance, especially real estate PF-related loans, which capital companies have expanded instead of the consumer finance sector where competition with credit card companies has intensified, is also a potential time bomb. The real estate PF sector is classified as a representative high-return, high-risk asset. According to NICE Credit Rating, as of the end of the first quarter, the outstanding balance of real estate PF loans by 28 capital companies reached about 20.9 trillion KRW, an increase of approximately 51.8% compared to the same period last year. The average annual growth rate over the past five years (2017-2021) also reached 18%.

An industry official said, "If the US base interest rate reaches around 3.5% by the end of the year, Korea's base interest rate is also likely to reach 3.0-4.0%, and based on this, (mortgage) loan interest rates rising to 6-7% will cause a full-fledged impact on the real estate market from the end of the year or early next year," adding, "For credit card companies with a large volume of corporate finance, if real estate PF loans deteriorate, they are likely to face management difficulties."

This content was produced with the assistance of AI translation services.