[Frozen Surface PF Market]② PF Loan Maturity Extensions Cause 'Illusory' Delinquency Rates... Many Hidden Defaults Remain

Extension of Real Estate Finance Maturities by Evasion Reflects Reduced Delinquency Rates
Real Estate Funds and REITs Are Not Included in Financial Company Soundness Classification
Accumulated Bad Debt Bomb Could Explode All at Once in the Future

There are many criticisms that the apparent soundness indicators, such as the delinquency rate of real estate project financing (PF) or the ratio of non-performing loans (NPLs), do not accurately reflect the actual PF default situation. This is because if the maturity of a PF loan is extended, exposures (risk exposures) that are highly likely to default or are already in a loss state are not recorded as delinquent or non-performing. Related experts commonly agree that there are quite a few PF loans that are effectively already in default, even though the defaults have not surfaced. It has also been diagnosed that losses not visible on the surface continue to grow in overseas real estate funds that are not recorded as delinquent.

‘PF Loan Maturity Extension’ Not Recorded as Delinquency

According to credit rating agencies, as of the end of June this year, the real estate PF NPLs overdue by more than three months among domestic securities firms' real estate exposures amount to about 1.2 trillion won. Considering that the total PF loans of securities firms amount to 27 trillion won, the defaults reflected in the figures are only a very small portion. Based on the NPL ratio, the soundness of PF is evaluated as not significantly deteriorated. Financial authorities have assessed that although the delinquency rate of PF loans at domestic financial companies is rising, it is not high enough to cause concern, and the recent upward trend has also eased.

However, the PF industry views the low delinquency rate as an optical illusion caused by PF loan maturity extensions. A developer, Company A, which was promoting a real estate development project in a certain region, recently extended the maturity of a bridge loan of around 100 billion won. A bridge loan is the fund borrowed from financial companies to purchase land before obtaining development project permits. The lending consortium for the bridge loan includes securities firms, insurance companies, and capital companies.

During the maturity extension process, the lending financial companies agreed to change the interest payment terms to 'interest in arrears.' Originally, interest had to be paid every three or six months, but the terms were changed to allow repayment of interest along with principal at maturity. It is known that the developer had run out of funds to pay interest, so the loan extension conditions were modified. Due to the maturity extension, financial companies did not record this bridge loan as delinquent. A member of the lending consortium said, "Although the developer failed to pay interest and it should actually be recorded as delinquent, the maturity extension prevents an increase in the delinquency rate."

It is also reported that many cases exist where the loan amount is increased to cover the interest expenses that the developer should regularly pay, thereby extending the maturity. Financial companies only see a slight increase in PF loan amounts and do not have to record it as delinquent or non-performing or set aside provisions. For this reason, it is analyzed that a significant amount of latent defaults are included even among PF loans not classified as delinquent or non-performing. In the case of bridge loan PF exposures where the development project has not progressed properly, there is a high possibility of losses occurring even if the maturity is extended.

An IB industry insider said, "Most of the bridge loans maturing in the first half of this year have extended their maturities," adding, "The extension of existing PF loan maturities is causing continuous delays in recognizing delinquencies or losses." Another insider explained, "Many developers purchased land at high prices before the interest rate hike, but due to rising construction costs and interest rates, the profitability of development projects is deteriorating over time," and "The pace of PF projects is slowing down, and cases of continuous loan extensions until the situation improves are increasing."

Real estate funds and REITs, which are not included in the soundness classification targets of financial companies, are also problematic. Since funds and REITs are excluded from non-performing assets, the real estate defaults of financial companies appear lower than they actually are. NICE Credit Rating analyzed that if the amount of funds or REITs with a scale of 1 billion won or more and losses exceeding 20% are included, the potential non-performing PF exposure of securities firms increases fivefold from 1.2 trillion won to about 6 trillion won. A representative of an alternative investment management company evaluated, "There is a high possibility that losses on overseas real estate investments by domestic institutional investors are significantly underestimated."

When Maturities Concentrate, a Default Bomb Could Explode All at Once

As financial companies defer real estate-related defaults into the future through maturity extensions, there is a forecast that crisis alarms like the September crisis warning will repeatedly sound. This is because the maturities of large-scale exposures related to real estate finance periodically continue to come due. There is concern that if loan extensions are not properly executed due to high interest rates or credit tightening at the time when maturities concentrate, a default bomb could explode all at once.

According to NICE Credit Rating, as of the first half of this year, potential non-performing exposures have maturities exceeding 1 trillion won on average every year until 2026. Since the exposures maturing are continuously extended with maturities of about one year, the annual PF and loan maturity amounts may continue to increase.

Meanwhile, the PF loan environment is deteriorating due to rising market interest rates and concerns about defaults. The senior PF loan interest rate, which was in the high 3% to 4% range, has recently risen to 9-10%. The mezzanine loan interest rate has increased to 15-17%, and there are almost no financial companies willing to invest in the riskiest subordinated loans. Even when trying to transfer bridge loans to main PF, most cases fail to secure subordinated investors, resulting in failure to match the main PF.

Market liquidity willing to invest in PF is drying up due to interest burden. Banks are severely limiting PF loan or guarantee limits and only participating in some main PFs. The same applies to second-tier financial institutions such as insurance companies and capital companies. Mutual finance institutions like MG Saemaeul Geumgo, Nonghyup, and Shinhyup have also reduced PF limits and lowered the LTV ratio (loan-to-value ratio based on real estate appraisal value) for PF loans.

An IB industry insider expressed concern, saying, "Unless the real estate market recovers and the profitability of development projects is restored, PF loan maturity extensions are likely to continue," and "If refinancing is not properly executed when maturities concentrate, defaults at financial companies could increase all at once, threatening macroeconomic stability."