"Capital Companies Growing Corporate and Investment Finance... Increased Default Risk Centered on Medium and Low Credit Firms"

Bank of Korea September Financial Stability Report
"Capital Companies Highly Dependent on Interfinancial Institution Transactions, May Threaten Entire Financial System in Crisis"

[Image source=Yonhap News]

[Asia Economy Reporter Yu Je-hoon] As capital companies expand their business areas into corporate and investment finance amid intensified competition in their core installment and lease businesses, an analysis has emerged that mid- to low-credit capital companies have a relatively high proportion of real estate project financing (PF), increasing the risk of insolvency.

According to the Bank of Korea's Financial Stability Report on the 23rd, the corporate and investment finance assets of domestic capital companies stood at approximately KRW 110.7 trillion as of the end of the first half, significantly surpassing the installment and lease assets (KRW 71.3 trillion), which had been their main business. Until 2015, corporate and investment finance assets were around KRW 37.2 trillion, falling short of installment and lease assets (KRW 43 trillion), but the ranking has reversed over the past few years.

In corporate loans, the proportion of real estate PF loans was high. The share of real estate PF loans within corporate loans surged from KRW 3.8 trillion to KRW 24.8 trillion. Investment finance also increased, centered on real estate (office and hotel) related securities and new technology finance assets, according to the Bank of Korea. This is attributed to the capital industry's automobile installment finance market share shrinking from 93.6% to 81.3% during the same period, a decline of over 10 percentage points, and the weakening competitiveness of core businesses due to household loan regulations, while asset markets (real estate and stocks) showed favorable trends.

The problem is that as real estate-related loans expand, the sensitivity of loan assets to the real estate market increases, and consequently, credit concentration risks in specific sectors and borrowers are growing. Amid the recent global interest rate hike trend due to inflation, the asset markets including real estate have turned bearish, raising concerns that if unsold housing increases, the risk of real estate PF loan defaults could rise. In fact, around the 2008 financial crisis, when nationwide unsold housing units increased by about 33,000 units (17,000 in 2007 and 50,000 in 2009), the delinquency rate on capital companies' real estate PF loans rose from 3.6% in 2009 to 16.2% in 2010, an increase of 12.6 percentage points.

Correspondingly, the credit enhancement of construction companies is weak. About 40% of the construction companies at capital company PF loan project sites have credit ratings of BBB or lower. The Bank of Korea noted, "The average balance per real estate PF loan of capital companies reached KRW 10.53 billion as of the end of March," adding, "If an individual PF loan defaults, the impact could be significant."

Meanwhile, liquidity risk is also expanding as the funding environment deteriorates. Capital companies, which lack their own deposit functions, had a market-based funding ratio (including credit finance bonds, short-term bonds, commercial paper, etc.) of 84.2% against borrowed debt as of the first half. Recently, the interest rate on credit finance bonds has exceeded 5% (based on AA+ rated 3-year bonds), and spreads have widened. Amid this, the proportion of credit finance bonds issued with maturities within two years increased from 38.3% last year to 50.0% in the first half, raising refinancing risks.

The Bank of Korea particularly diagnosed that considering the fund operation structure and soundness indicators, the risk of insolvency is increasing for mid- to low-credit capital companies with credit ratings of A or below. Their corporate and investment finance asset ratio was 64.4% as of the end of the first half, significantly higher than that of high-credit companies (46.8%), and the proportion of real estate-related loans within corporate loans was also 56.5%, 11.4 percentage points higher than that of high-credit companies, making them relatively vulnerable to a downturn in the real estate market. Delinquency rates have also reversed to an upward trend since the fourth quarter of last year.

The Bank of Korea stated, "Although capital companies are significantly increasing their corporate and investment finance proportions, this is not their area of expertise, and it is concerning that mid- to low-credit companies with lower risk assessment capabilities have a high share of (corporate and investment finance) handling," adding, "Since capital companies heavily rely on inter-financial institution transactions, the insolvency of some could spread instability throughout the financial system, so it is necessary to strengthen related monitoring."

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