High Dependence on Construction Companies in 'Real Estate PF'... "Risk Increases if Funding Tightens"

Amid growing concerns about the real estate project financing (PF) market due to the Taeyoung Construction workout crisis, an analysis has emerged suggesting that if construction companies continue to face liquidity shortages, the inherent characteristics of real estate PF could increase risks even for relatively sound projects or companies.

On the 29th, the Korea Institute of Finance diagnosed this in its report titled "A Study and Implications on the Risks of Real Estate PF in Korea." The report noted that because Korea's PF heavily depends on construction companies, any liquidity crunch in these companies could lead to a higher risk of project development being halted.

Korea's real estate PF has evolved since the 2011 savings bank crisis, with measures such as total credit limit restrictions. Construction companies have since provided credit enhancements with reduced burdens, such as responsibility for project completion guarantees. Additionally, the range of credit enhancement providers has diversified, including securities firms offering credit enhancements related to securitization.

On the 11th, the fate of Taeyoung Construction, which applied for a workout (corporate restructuring) after failing to repay real estate project financing (PF) loans worth around 9 trillion won, is being decided, creating tension at Taeyoung Construction in Yeongdeungpo-gu, Seoul. Photo by Jo Yongjun jun21@

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However, the report pointed out that the high dependence on construction companies means that risks could simultaneously increase depending on their financing conditions. Currently, bridge loans or main PF lending groups decide on loan approvals by considering the construction company's credit rating and construction capability evaluation rankings, and they require responsibility for project completion or conditional debt assumption from the construction companies.

In particular, many mid-sized and small construction companies still provide payment guarantees to secure competitiveness. When issuing securitized securities, the credit rating of these securities is mostly linked to the construction company's credit rating, and credit enhancements such as purchase guarantees provided by securities firms often include clauses that exempt obligations if the developer's or construction company's credit rating declines.

The researcher analyzed, "If construction companies' profitability continues to weaken due to factors such as a real estate market downturn, rising raw material prices, and sustained interest rate hikes, the risk associated with construction companies could increase beyond current levels." He further explained that structural issues?such as developers' low capital strength, repayment of bridge loans with main PF funds, use of buyers' funds for construction costs, and reliance on construction companies' creditworthiness?make the system prone to defaults during economic downturns.

Therefore, he emphasized the need for government support based on market principles, such as timely liquidity provision to prevent risk contagion from real estate PF defaults and incentives for companies that diligently manage risks.

The researcher added, "To reduce the risk of real estate PF defaults, it is necessary to provide support based on evaluations and market principles to prevent moral hazard," and explained, "In the long term, it is essential to understand the incentives of PF market participants and improve the market structure."

Taeyoung Construction, which is experiencing a liquidity crisis due to real estate project financing (PF), has applied for a workout. On the 5th, the construction site of Taeyoung Construction's Seongsu-dong development project located in Seongdong-gu, Seoul, has come to a halt. Photo by Jinhyung Kang aymsdream@

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Regarding the current real estate PF market situation, it was assessed as being at a 'manageable level.' Considering the environment including construction companies' creditworthiness, contingent liabilities of PF, and credit enhancement institutions, the situation is not comparable to the construction market or savings bank crisis levels seen after the financial crisis.

In fact, within three years after the global financial crisis, over 40% of construction companies with credit ratings had corporate bonds and commercial paper (CP) rated as non-investment grade, whereas currently, these figures stand at approximately 19% and 2%, respectively.

Moreover, credit enhancements by construction companies are mainly limited to responsibility for project completion, so the risk of major construction companies' financial health deteriorating due to PF contingent liabilities is lower than during the global financial crisis. Credit enhancements related to securitized securities issued by securities firms are also in a solid state, supported by improved risk management capabilities and capital adequacy of the securities firms themselves.

Meanwhile, financial authorities are accelerating their response to prevent the spread of real estate PF defaults. Following major commercial banks and securities firms, the Financial Supervisory Service (FSS) convened executives from savings banks, capital companies, and mutual finance institutions on the 25th, urging them to build up provisions for real estate PF more aggressively. It is reported that the FSS requested that bridge loans unlikely to convert to main PF be recognized as 100% expected loss at settlement.

Reflecting market concerns over construction company defaults, the FSS prepared "Precautions for Settlement and External Audit of Construction and Other Order-Based Industries" and selected accounting treatment of order-based industries as a key audit focus. In construction and shipbuilding industries, long-term projects often recognize construction revenue based on progress rates, which can be exploited to inflate profits by disguising losses. There are also cases where significant contingent liabilities or provisions are omitted, undermining the reliability of financial statements.

Jin Gyu-jong, Director at the FSS, stated, "Cases of accounting violations such as manipulating construction progress rates or omitting important payment guarantees in financial statement notes continue to occur," adding, "We will strictly manage and supervise by selecting order-based industry accounting treatments as a key audit focus and conducting intensive inspections."

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