Even Major Construction Companies Can't Be Trusted... Concerns Over Chain Failures in Bridge Loans

From Daewoo E&C's Perspective, It Can Be Seen as a Rational Decision
"Intentional Default by Top 10 Construction Firms Is Unthinkable"
Possibility of Increased PF Defaults in Capital and Securities Firms with Many Bridge Loans

[Asia Economy Reporter Lim Jeong-su] The dominant reaction is that it has become difficult to trust guarantees or construction contracts from major construction companies due to the bridge loan default at a construction site guaranteed by Daewoo Engineering & Construction. There are growing concerns that the ripple effects could spread, with increasing cases of construction companies intentionally defaulting without entering into responsibility-for-completion contracts. Along with the increase in non-performing assets of financial companies due to unsold units, the financial sector is on edge over the responsibility-for-completion risks of construction companies.

According to the investment banking (IB) industry on the 6th, as of the end of last year, the contingent liabilities of construction sites for which Daewoo E&C provided joint guarantees are estimated to be around 500 billion to 600 billion KRW. It is known that the projects with responsibility-for-completion obligations already exceed 6 trillion KRW. The company’s own financial situation is sound, having posted a record operating profit of 760 billion KRW last year. However, if cases where responsibility-for-completion contracts fail to materialize between the construction contract and the main project financing (PF) increase, there is a high possibility that loans to guaranteed projects by large construction companies like Daewoo E&C will become significantly non-performing.

Daewoo E&C Building, Euljiro, Seoul.

An IB industry insider said, "It is the first time in decades of working in the project financing (PF) industry to see a top 10 construction company by construction capability intentionally defaulting on projects where they have signed construction contracts and provided guarantees for bridge loans by refusing to provide responsibility-for-completion agreements," adding, "Daewoo E&C is also restructuring projects by assessing profitability to decide whether to proceed with other projects, so similar cases may increase."

Responsibility-for-completion is a kind of promise by the contractor to complete the construction on time and without issues. From the perspective of the PF lending consortium that loans money to construction projects, if the construction is not carried out as designed and on schedule or if the completion permit is not obtained, the buyers’ move-in is delayed and PF loan recovery becomes difficult. Therefore, the contractor’s responsibility-for-completion is an essential credit enhancement measure for transitioning from bridge loans to main PF. The agreement also includes a clause that the contractor will assume the repayment responsibility of the main PF on behalf of the developer if they fail to properly fulfill the responsibility-for-completion.

When financial companies trust the contractor’s responsibility-for-completion and provide main PF loans, the developer uses that money to repay the bridge loan and pays the construction costs to the contractor with whom they have a construction contract. Without the contractor’s responsibility-for-completion agreement, it is difficult to secure the main PF, and there is no money to pay construction costs, making it impossible to proceed with the project. In this case, the existing bridge loan is either extended until the project proceeds normally or, if no replacement contractor willing to participate emerges, it leads to default.

An industry insider said, "From Daewoo E&C’s perspective, it can be seen as a rational decision," but added, "The shockwave to the lending consortium and PF industry, which have trusted contractors’ responsibility-for-completion, is significant." He said, "While loan defaults on projects promoted by small and medium-sized construction companies with weak financial strength due to the real estate market downturn were somewhat anticipated and provisions were being prepared, no one expected a top 10 construction company to intentionally default."

The problem is that as the business viability of real estate development projects declines due to increasing unsold units, cases where not only small and medium-sized but also large construction companies do not proceed with projects despite having construction contracts may increase. According to the Ministry of Land, Infrastructure and Transport, as of the end of December last year, the nationwide unsold housing units stood at 68,107, nearly quadrupling from 17,710 units a year earlier. In particular, in November last year, the number increased by 10,810 units in one month, followed by an increase of 10,080 units in December, marking two consecutive months of over 10,000 units increase.

There is a forecast that even large construction companies will be reluctant to take on construction projects in unprofitable sites and bear losses. A securities firm PF executive said, "With rising raw material costs increasing construction expenses and pressure on sale prices intensifying, the momentum to push forward construction projects is weakening," adding, "If the atmosphere spreads where large construction companies also assess profitability before deciding whether to participate in construction projects they have guaranteed, the PF defaults of capital companies and securities firms with large bridge loan exposure could further expand."