'Reflecting Unsold Housing Losses'... First Case of Construction Company Rating Outlook Downgrade

Hankyung Credit Rating, 16 Construction Companies' Second Half Regular Rating Evaluation
Shinsegae Construction Reflects Daegu Unsold Inventory Loss
Rating Outlook Downgraded to 'Negative'

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Concerns over the realization of contingent liability risks in real estate project financing (PF) have increased, leading to a downgrade in the credit ratings of GS Construction and Dongbu Construction. The rating outlooks for Taeyoung Construction and Shinsegae Construction have been changed to 'negative.' Notably, Shinsegae Construction is the first case to change its credit rating by reflecting poor pre-sale performance in its allowance for doubtful accounts. As uncertainty in the pre-sale market is expected to expand, additional credit rating changes related to this are anticipated.

According to Korea Ratings on the 28th, in the regular evaluation of commercial paper and electronic short-term bonds of 16 construction companies, GS Construction's unsecured bonds and commercial paper credit ratings were downgraded from 'A+' and 'A2+' to 'A' and 'A2,' respectively. Dongbu Construction's commercial paper and short-term bond ratings were lowered from 'A3+' to 'A3.' Taeyoung Construction and Shinsegae Construction's rating outlooks were downgraded from 'stable' to 'negative.'

Korea Ratings explained, "The downgrade of GS Construction and Dongbu Construction's credit ratings reflects the outlook that, amid expanded financial burdens due to investment growth over recent years, it will be difficult to achieve a financial structure consistent with their previous rating levels in the short term due to the downturn in the housing market and worsening market conditions."

Korea Ratings added, "In the case of Shinsegae Construction, since the housing market uncertainty began to expand in 2022, the allowance for doubtful accounts has been reflected due to poor pre-sale performance. This is significant as it is the first case where the credit rating was changed due to the reflection of pre-sale related allowance for doubtful accounts."

Shinsegae Construction has recognized doubtful accounts at projects with low pre-sale rates in Daegu, where market conditions are unfavorable, including Villiv Radice (KRW 19.6 billion), Villiv Lucent (KRW 11.4 billion), and Villiv Heritage (KRW 5.5 billion). The cumulative bad debt expense as of the end of the third quarter (September) this year was KRW 46.3 billion. The total scale of ongoing projects in Daegu currently amounts to KRW 629.1 billion. Among these, the total contract amount for projects with low pre-sale rates (Villiv Heritage, Villiv Lucent, Villiv Radice) is KRW 330 billion.

Korea Ratings pointed out, "For projects with low pre-sale rates, there is a possibility of additional recognition of doubtful accounts due to the contraction of the pre-sale market. Considering the high cost burden and uncertainty in the pre-sale market, excessive financial burdens are expected to continue."

Meanwhile, construction industry sales are expected to decline next year compared to this year, as supply reduction will be fully underway from 2023. Construction companies have been continuously recalculating completion costs since the second half of 2022, reflecting the rising cost trend.

Hyun Kim, a senior researcher at Korea Ratings, noted, "Although cost burdens may ease somewhat due to decreased demand for construction materials from reduced groundbreaking and cost realization from new project incorporations, sluggish economic conditions and sustained high interest rates are lowering real purchasing power, making aggressive pre-sale price setting difficult."

Kim further analyzed, "Profitability improvement is expected to be difficult as the possibility of bad debts arises, such as an increase in unsold units after completion, which is a direct cause of construction company bad debts."

Additionally, the reduction of PF-related exposure by financial institutions, leading to the realization of PF contingent liability risks, is also a burden. Considering cash flow deterioration due to downsizing, working capital burdens from construction receivables, and funding needs due to worsening financial conditions, this could translate into financial burdens for construction companies.