Lotte City Development Project in Shenyang, China, Left Only with Debt Celebration

Lotte City Development Project Site in Shenyang, China

[Asia Economy Reporter Lim Jeong-su] Lotte Property Shenyang, established in Hong Kong by major affiliates of Lotte Group for the Lotte City development project in Shenyang, China, is facing a large-scale debt crisis after incurring massive losses due to the suspension of the local Lotte City project. It is reported that they are under pressure to repay nearly 3 trillion KRW in borrowings from foreign banks and financial institutions that previously participated as major lenders. Since the construction was halted due to the THAAD incident, Lotte Group has been unable to make a strategic decision on whether to continue or withdraw from the project, resulting in a 'chicken rib' situation that has turned into a financial burden.

According to the investment banking (IB) industry on the 26th, Lotte Property Shenyang recently received a foreign currency loan of 208 million USD under the management of Shinhan Investment Corp. The loan has a maturity of one year, with a condition that the loan must be repaid in full upon maturity. Shinhan Investment Corp. issued asset-backed commercial papers based on the principal and interest of the loan after acquiring it. Hotel Lotte, which invested equity in this project, provided credit support such as capital replenishment agreements to the special purpose company (SPC) during the loan securitization process.

Lotte Property Shenyang uses the loan to repay existing borrowings from banks. It is known that the borrowings linked to the Shenyang project, which are approaching maturity, amount to nearly 3 trillion KRW. A Lotte Group official explained, "The borrowings taken as operating funds for the Shenyang Lotte City development project amount to about 3 trillion KRW," adding, "As the loan maturities come up frequently, the funds are continuously being refinanced."

According to a local financial company official in Hong Kong, Lotte Property Shenyang is currently under pressure to repay loans from Japanese banks and others that provided funds in the early stages of the project. Since the possibility of resuming the project is low, Lotte Property Shenyang is accumulating losses while depleting all equity invested by its affiliates.

Lotte Property Shenyang was established in 2008 for the Lotte City development project in Shenyang, China, constructed by Lotte Group. Lotte Asset Development (37%), Lotte Construction (31%), Lotte Shopping (18%), and Hotel Lotte (14%) invested 200 million USD. This project is a mega development including a theme park (Lotte World Adventure), department stores, cinemas (Lotte Cinema), hotels, offices, and residential facilities.

In the first phase, department stores, marts, and offices were constructed and put up for sale, but sales performance was poor. The second phase planned to build hotels and amusement facilities, but construction was halted by Chinese authorities in 2016 due to the THAAD incident. Although China allowed construction to resume in 2019, Lotte did not restart construction due to project performance and financial issues.

Lotte Property Shenyang has been in a state of capital erosion as losses accumulated due to the construction halt. The book value of the shares in Lotte Property Shenyang held by Lotte Asset Development, Hotel Lotte, and Lotte Shopping is zero.

Consequently, the financial burden on the parent companies that invested in this project has also increased. Lotte Asset Development, which holds the largest stake, has reflected equity method losses every year since investing in Lotte Property Shenyang. The cumulative equity method loss from 2008 to 2019 reached 145 billion KRW. Due to increasing losses in the Shenyang project and poor performance in other businesses, Lotte Asset Development is currently in a state of complete capital erosion.

Hotel Lotte bears contingent liabilities related to Lotte Property Shenyang in addition to its own financial burdens. As of the end of the third quarter last year, the guarantees provided by Hotel Lotte for the Shenyang project exceeded 800 billion KRW. Including capital replenishment agreements and other commitments beyond direct guarantees, the actual contingent liability burden is expected to be even greater.

Hotel Lotte attempted to alleviate some of the financial burden of the Shenyang project by raising funds through an initial public offering (IPO), but repeated failures to go public have prolonged the burden. An IB industry official said, "With the added impact of COVID-19, Hotel Lotte's credit rating is rapidly deteriorating," and predicted, "The contingent liability burden could increase further during the refinancing process of borrowings related to the Shenyang project."

With the added impact of COVID-19, the Shenyang project has fallen into a 'chicken rib' state where Lotte cannot proceed nor withdraw. A Lotte Group official stated, "There are no plans to inject additional funds into the Shenyang project," adding, "An exit strategy such as asset sales has not yet been prepared." An IB industry official predicted, "Borrowings related to the Shenyang project are likely to be refinanced through domestic banks or capital markets with credit support such as guarantees from affiliates."