[Poor Debt Market Stirring] ① Crisis as Opportunity... Signs of Boom Amid High Interest Rates and Recession

Increasing Trend of NPLs in Financial Sector Including Household, Corporate, and Real Estate PF
Investment Market Stirred by Rising Sale Bids

Amid macroeconomic and financial market instability characterized by high interest rates, low growth, and real estate project financing (PF) defaults, a paradoxically emerging market is gaining attention. The non-performing loan (NPL) market is showing signs of bottoming out and expanding again. Due to rising market interest rates and a downturn in the real estate market, financial institutions' delinquency rates have increased, and the total volume of NPLs has started to grow. With high interest rates and economic recession expected to persist for some time, the NPL market is once again in the spotlight.

Increase in Financial Institutions' NPLs... Rising Non-Performing Loans in Household and PF Sectors

According to the Financial Supervisory Service and the investment banking (IB) industry as of the 8th, domestic financial institutions' NPLs have been increasing again since bottoming out in the third quarter of last year. Bank sector NPLs hit a low of 9.7 trillion KRW in Q3 last year, rising to 10.1 trillion KRW by the end of last year and 10.4 trillion KRW in the first quarter of this year.

NPLs refer to loans, private bonds, and debt guarantees that have been overdue for more than three months and carry potential risks in principal and interest recovery. Financial institutions classify loans by soundness (recoverability) into normal loans, loans under observation (1-month delinquency), substandard loans (3-month delinquency), doubtful loans, and estimated loss stages. Among these, substandard, doubtful, and estimated loss loans are collectively classified as 'substandard loans,' which are referred to as NPLs, meaning non-performing loans that generate no income or fail to produce results.

By loan type, corporate loan NPLs increased from 8 trillion KRW in Q3 last year to 8.2 trillion KRW in Q1 this year, while household sector NPLs, mainly real estate-secured loans, rose from 1.5 trillion KRW to 2 trillion KRW during the same period. The NPL ratio in total bank loans also rose from a low of 0.38% last year to 0.41%. This represents a 0.03% (1bp=0.01%P) increase over six months, amounting to approximately 700 billion KRW.

NPLs in the secondary financial sector, including securities firms, are also increasing, centered on PF loans. As of the first half of the year, the NPLs of 25 domestic securities firms totaled about 3.7 trillion KRW, up 1.1 trillion KRW from the end of last year. Among these, PF loans accounted for 1.2 trillion KRW, increasing by about 400 billion KRW over six months.

NPLs in insurance companies, capital companies, and savings banks have also started to show an increasing trend. The delinquency rate for total loans in the savings bank industry was 5.33% as of the end of June, up 1.92 percentage points from the end of last year. The NPL ratio rose to 5.61%, an increase of 2.27 percentage points over the same period.

Industry insiders expect financial sector NPLs to continue rising as corporate and household credit quality deteriorates. An NPL investment firm representative said, "If high interest rates and economic downturn persist, vulnerable borrowers in households and corporations will increase, leading to continuous growth in NPLs across financial sectors. Including the real estate PF sector, where projects have not progressed and maturities have only been extended, the volume of NPLs is likely to increase rapidly in the second half."

Increase in NPL Sales... Investment Opportunities in a Recession

NPL sales are also increasing. Financial institutions handle NPLs mainly by either recovering part of the debt through public or private auctions on loan collateral or by selling the debt at a discount to NPL investment companies or asset management firms. They may also retain the debt while normalizing it or, conversely, write it off.

Among these, external sales serve as investment opportunities for potential investors during economic downturns. When NPLs accumulate, financial institutions must set aside loan loss provisions according to prescribed reserve rates, so they choose to sell to reduce the burden of non-performing ratios and provisions. Investors can profit by purchasing NPLs cheaply, enhancing their value through proprietary know-how, or increasing recovery rates.

In the first half of this year, bank sector NPL sales amounted to 1.8 trillion KRW, doubling the 900 billion KRW recorded in the first half of last year. Sales in the second half are also expected to exceed 1 trillion KRW, a significant increase from 370.6 billion KRW last year. The NPL ratio in the secondary financial sector is also on the rise, suggesting that NPL sales volumes are likely to continue growing.

The scale of domestic bank sector NPLs surged during the 1997 foreign exchange crisis before entering a downward trend. They spiked again during the 2008 global financial crisis, peaking at 30 trillion KRW in 2015. Since then, due to falling interest rates and economic recovery, NPLs have decreased annually, falling below 10 trillion KRW last year. The low interest rates and economic boom also reduced NPL sales volumes, causing difficulties in the NPL market. The bank sector's NPL sales ratio, which was about 25% of total NPLs in the past, has recently dropped to around 20%.

An investment banking (IB) industry insider said, "The NPL market has rapidly expanded following major economic and financial crises in the past. With prolonged high interest rates and recession, the total volume and sales of NPLs in corporate and household sectors will continue to increase, leading to a resurgence in the NPL market." However, they added, "As more specialized NPL investment firms and asset management and capital companies participate in the NPL market, competition is gradually intensifying."