FSS Explains Reason for Demanding 100% Provisioning of Expected PF Losses

Recognition of Accounting Loss... Reduced Burden of Gyeong·Gongmae
Expecting Land Price Decline Due to Gyeong·Gongmae
Effect of Lowered Sale Prices... Big Picture of Smooth PF Landing

[Image source=Yonhap News]

The reason the Financial Supervisory Service (FSS) has demanded that financial institutions such as savings banks and securities firms fully reserve 100% of expected losses on real estate project financing (PF) is interpreted as an effort to guide a soft landing of real estate through auction and re-auction of projects with low viability. The idea is that if construction companies can purchase land at reduced prices through land auctions and re-auctions, they can also lower the sale prices of the units.

According to the supervisory authorities on the 7th, the FSS is activating a roadmap to "clean up" bad real estate PF loans, which are considered a "time bomb" for the Korean economy. For projects that have had their maturities extended multiple times, financial companies are required to reflect 100% of expected losses on their books, and during the second quarter, additional provisions will be encouraged through reclassification of bad projects. At the "2024 Business Plan Press Conference" held at the Seoul Yeouido headquarters on the 5th, it was emphasized that "projects with significantly reduced viability due to repeated grace periods or maturity extensions must recognize 100% of expected losses in the 2023 year-end settlement." The plan is to resolve bad projects within the year, and financial companies that fail to recognize losses in a timely manner may face "market exit."

According to NICE Credit Rating, as of the third quarter of last year, the total scale of real estate PF reached 134 trillion won. By type, bridge loans and main PF loans were 30 trillion won and 104 trillion won, respectively. The delinquency rate on PF loans in the financial sector rose from 1.19% at the end of 2022 to 2.42% at the end of the third quarter of 2023. The problem lies with savings banks. During the same period, the delinquency rate on PF loans at savings banks surged from 2.05% to 5.56%. This is why the FSS recently conducted one-on-one meetings with individual savings banks related to real estate PF. The FSS plans to receive additional (provision) reserve plans from financial companies by the 8th and check the status.

At the end of last year, the FSS also required that projects with significantly reduced viability due to repeated maturity extensions recognize 100% of expected losses at settlement. This is to prevent financial companies from lowering their provision amounts due to maturity extensions of PF projects.

When reserving provisions for real estate PF, parts where credit is strengthened through collateral or guarantees are excluded. Provisions are recognized for loans without collateral or where credit enhancement is difficult, and if the loan maturity is extended, losses do not have to be recognized. In other words, if a PF project with low viability is recognized as a loss, financial companies can reduce the burden of land auction and re-auction.

Kim Ye-il, senior researcher at Korea Credit Rating, explained, "Since last year, encouraging auction and re-auction of PF projects has been the right direction, but at that time there was no demand to absorb it, and high interest rates made it difficult to resolve. If expected losses are recognized 100% this year, when the situation is relatively better, there will be greater incentives for creditors to proceed with auction and re-auction and project restructuring, which can lead to a decline in land prices."

Ultimately, the goal is to induce construction companies to purchase the lowered-priced land so that sale prices can also be reduced. FSS Governor Lee Bok-hyun’s remark at the press conference, "The Ministry of Land, Infrastructure and Transport and others have also introduced policies, but the reason construction companies are not moving is the price issue," and "Since the land price ratio is large, if the FSS’s intention regarding bridge loans succeeds, there will be a price adjustment," is interpreted in this context.

A financial investment industry official said, "Until last year, banks had already reserved provisions for PF in advance, and some securities firms only began reflecting losses in the second half of the year. With many CEOs in the securities industry replaced, the supervisory authorities’ demand for PF provision reserves is timely in terms of a 'big bath' for earnings." He added, "If a decline in land prices is confirmed, PF investment will continue, centered on financial companies with ample funds."

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