[Bank as a Pillar] ④ The Biggest Risk 'Real Estate PF'... What Is the Solution?

Changed Bank Fundamentals Over 10 Years... "Banks Must Separate Wheat from Chaff in Prime PF Projects"

[Asia Economy Reporters Jehoon Yoo and Aeri Boo] The potential biggest risk facing the Korean financial market is the deterioration of real estate project financing (PF). Just as the PF defaults during the 2008 global financial crisis escalated into the 'Savings Bank Crisis' in 2011, there are growing concerns this year that the real estate market downturn could severely impact not only construction companies but also secondary financial institutions such as securities firms and capital companies. The financial sector believes that even if real estate PF defaults materialize this time, banks can play a 'supporting' role. Thanks to a much stronger foundation compared to over a decade ago during the financial crisis, banks can act as firefighters supplying liquidity to the market.

According to the financial sector on the 23rd, as of the end of June this year, real estate PF loans across the entire financial sector (banks, insurance companies, credit finance companies, savings banks, securities firms) total 112 trillion won. Including securitized assets such as real estate PF asset-backed commercial paper (PF-ABCP) issued by securities firms based on various development projects, the related market size exceeds 150 trillion won.

Real estate PF refers to a financial technique where future cash flows expected from a certain real estate development project, such as sales proceeds, are used as assets to raise funds from the financial sector. Specifically, it consists of 'bridge loans' to finance land acquisition and 'main PF' loans to cover various costs from construction commencement to sales.

The Bank of Korea raised the base interest rate by 0.5 percentage points, and the real estate transaction market is expected to experience a prolonged winter. On the 13th, a red light was on at a traffic signal near an apartment in downtown Seoul.

The Real Estate PF Market Different from 10 Years Ago

The real estate PF market today differs greatly in both quantity and quality compared to over 10 years ago when the Savings Bank Crisis occurred. First, as of the end of June this year, the PF loan scale stands at 112.2 trillion won, a 42.2% increase compared to 78.9 trillion won at the end of June 2008 during the financial crisis. It has also roughly doubled compared to 59.5 trillion won at the end of 2018, about four years ago.

The qualitative difference is also significant. During the financial crisis, banks were the main providers of PF loans, but recently, secondary financial institutions such as securities firms, capital companies, savings banks, and insurance companies have led PF lending. As of the end of June this year, the real estate PF loan balances by sector are ▲insurance companies (43.3 trillion won), ▲credit finance companies (26.7 trillion won), ▲savings banks (10.7 trillion won), and ▲securities firms (3.3 trillion won), with secondary financial institutions accounting for over 80%. Particularly, credit finance companies, savings banks, and securities firms tend to be involved as subordinated lenders in relatively lower creditworthiness projects, thus carrying higher relative risk.

With the real estate market on a downturn due to U.S. interest rate hikes and global raw material price increases caused by the Russia-Ukraine war, the industry fears a large-scale real estate PF default next year. Recently, incidents such as the Legoland case and the non-exercise of call options on new capital securities by Heungkuk Life Insurance have frozen the bond market, effectively putting real estate development projects nationwide into a 'business suspension' state.

The financial and construction sectors argue that the government and financial companies should proactively prepare for real estate PF defaults by activating Korea Asset Management Corporation (KAMCO)'s non-performing loan (NPL) acquisition program and establishing bad banks like the 'Real Estate PF Normalization Bank,' similar to the 2011 Savings Bank Crisis. During the financial crisis, as real estate PF loans deteriorated mainly in commercial banks and savings banks due to the sluggish real estate market, the government acquired PF-related NPLs of savings banks through KAMCO's restructuring fund and carried out normalization efforts. Commercial banks also formed a Real Estate PF Normalization Bank with Korea Asset Management Corporation (KAMCO) to handle project sites.

A CEO of a small to medium-sized capital company said, "The government should proactively purchase distressed or potentially distressed projects through KAMCO," adding, "Although there may be criticism of moral hazard, if proactive measures are not taken, a problem that could be stopped with a hoe might become impossible to stop even with a rake."

KB Financial Group Management Research Institute also recently released a report titled 'Policy Recommendations for a Soft Landing of the Housing Market,' advocating for ▲government-led establishment of a PF normalization bank and credit guarantee fund guarantees on construction payment receivables loans (to help construction companies secure working capital) ▲issuance of primary collateralized bond obligations (P-CBOs) to operate and expand liquidity support programs for construction companies. Park Cheolhan, a research fellow at the Korea Construction Industry Research Institute, likened the construction industry's situation to arteriosclerosis. He said, "Although liquidity supply has somewhat improved the situation, if an unexpected rupture occurs anywhere, the crisis could spread rapidly," adding, "The crisis has not yet materialized, but a bad bank would act like a thrombolytic agent or emergency room transfer in an emergency, so preparation is necessary."

Banks Should Actively Support Prime Projects and Play Their Role

Meanwhile, the role of banks is also being emphasized. Fortunately, banks have significantly reduced risks related to real estate PF loans after experiencing the 2008 global financial crisis. According to the Korea Construction Industry Research Institute, as of the end of June this year, commercial banks accounted for only 25% (about 28 trillion won) of the total real estate PF loan balance across the financial sector. Banks themselves have strengthened their capacity since the financial crisis. A financial sector official said, "During the 2008 financial crisis, commercial banks provided senior PF loans mainly to low-risk large projects, and secondary financial institutions like securities firms filled the gaps," adding, "Even if PF loan defaults materialize, the likelihood of contagion to banks is low."

In particular, the industry widely views that distinguishing 'good' from 'bad' among defaulted PF loan projects is a role that banks must play. Currently, financial authorities are assessing the quality of each PF project, but they lack the 'expertise' that banks holding the purse strings possess. A financial sector official said, "No matter how much the government scrutinizes, it cannot evaluate project feasibility as well as the banks that directly provide PF loans. The order should be for banks to first support and save prime PF projects, and then the government handles the remaining distressed projects," emphasizing, "Financial authorities should support banks to directly enter the PF market and act as firefighters to save prime projects."

Meanwhile, regarding households that would bear the full brunt of a real estate market hard landing, so-called 'Yeongkkeul-jok' (those who borrowed to the maximum) and 'Gaptu-jok' (gap investors), there are also claims that banks can play a supporting role. Kim Kangmin, head of the real estate research team at KB Financial Group Management Research Institute, said, "If the real estate market hard lands, banks could alleviate the burden on marginal borrowers by extending the maturity of existing loans, among other measures."

Beyond this, there is analysis that financial companies can act as a proactive safety net. Bae Hyunki, CEO of Wells Guide and former head of Hana Financial Management Research Institute, said, "Although it is an individual's responsibility, leaving house-poor people who bought homes beyond their means to go bankrupt is not the best solution," adding, "Financial companies could purchase the homes of borrowers on the verge of default through a 'Sales and Leaseback' method, lease them, and issue asset-backed securities (ABS) based on these assets to sell to institutions and individuals, thereby revitalizing the rental business and preventing a catastrophic situation." Bae explained, "For households burdened by high interest rates, this allows them to resolve excessive loans and continue living in their homes as tenants," noting, "This was the approach private equity firm Blackstone took in the U.S. during the 2008 global financial crisis when housing prices plummeted."