Polarization Deepens in Construction Company Bonds... Even 'A' Grade Cannot Be Assured

Contingent Liability Risk from Taeyoung Construction
AA-Rated Investment Sentiment Concentrates
Non-Investment Grade Bond Aversion Likely to Deepen

Taeyoung, Lotte, Hyundai, GS Construction Face Over 50% PF Guarantee Burden at Q3 End

As the contingent liability risk of real estate project financing (PF) related to Taeyoung Construction expands, an analysis suggests that the polarization phenomenon in construction companies' corporate bonds will intensify. If credit spreads rise mainly among lower-rated bonds, investment loss possibilities are also expected.

Taeyoung Construction Workout... Corporate Bond Polarization Expected to Intensify

Concerns about the credit (corporate bond) market are growing due to Taeyoung Construction's workout application. Although the possibility of a rapid widening of credit spreads is low, differentiation between ratings is expected to deepen.

According to Hana Securities on the 3rd, the amount of construction company bonds maturing in 2024 is estimated at 3.2 trillion KRW. This accounts for about 4.9% of the total corporate bond maturity amount of 69 trillion KRW. The amount of construction company bonds maturing in the first half of this year is 2.4 trillion KRW, about three times more than the second half (800 billion KRW).

Corporate bond yields are determined by 'government bond yields + credit spreads.' Domestic credit spreads rapidly narrowed along with the decline in government bond yields but recently, due to level burdens and Taeyoung Construction, pressure to widen credit spreads has increased. For 'AA' grade bonds, the spread moved from around -10bp (1bp=0.01 percentage point) in November last year to positive territory in December last year.

The securities industry believes that the impact of Taeyoung Construction's workout on credit spreads will not be significant. However, they point out that avoidance of non-investment grade bonds will intensify. In the construction sector, investment sentiment is likely to focus on 'AA' grade or higher. This is because, following Taeyoung Construction's workout application, credit spreads of construction companies' corporate bonds may rise depending on their situation.

Kim Eun-gi, a researcher at Samsung Securities, analyzed, "The biggest feature of this year's credit (corporate bond) market is the prolongation of polarization," adding, "Even if the decline in government bond yields due to expectations of a base rate cut expands buying of high-grade corporate bonds rated 'AA' or above, it is unlikely to extend to non-investment grade bonds rated 'A' or below."

Looking at the amount of corporate bonds maturing in the first half of this year for major construction companies, SK Ecoplant (A-) has the largest amount at 448 billion KRW. This is followed by Lotte Construction (A+) with 435 billion KRW, HLD&I Halla (BBB+) 227 billion KRW, Hyundai Construction (AA-) 220 billion KRW, DL E&C (AA-) 200 billion KRW, POSCO E&C (A+) 140 billion KRW, and Hanshin Engineering & Construction (BBB-) 135 billion KRW.

The construction companies drawing market attention are those rated 'AA' or below. HLD&I Halla and Hanshin Engineering & Construction are speculative grade and have large maturing amounts. Choi Seong-jong, a researcher at NH Investment & Securities, said, "Credit spreads may rise depending on construction companies' credit ratings and financial conditions," adding, "An increase in credit spreads means a decline in corporate bond prices, which in some cases can lead to loss zones."

Real Estate PF Risk to Determine Credit Ratings

Especially, construction companies with many unstarted real estate PF projects or a high proportion of regional projects are expected to face greater burdens. According to Korea Credit Rating data, as of the end of Q3 last year, construction companies with PF guarantee amounts exceeding 50% of equity capital include Taeyoung Construction (373.6%), Lotte Construction (212.7%), Hyundai Construction (121.9%), HDC Hyundai Development Company (77.9%), GS Construction (60.7%), KCC Construction (56.4%), and Shinsegae Construction (50.0%).

According to NICE Credit Rating, as of June 2023, the nationwide unsold housing inventory stood at 66,388 units. Although this is a reduction from the peak of 75,438 units recorded since 2019, it remains at a high level. Particularly, the inventory of unsold units after completion, considered a toxic stock, has continuously increased since November 2022, reaching 9,399 units as of June 2023.

The risk of unsold units is intensifying mainly in regional areas. The nationwide average initial sales rate was 49.5% in Q1 last year and 71.6% in Q2. The Q1 figure was the lowest since 2019. Although the Q2 figure rebounded, experts caution it is too early to be reassured. Initial sales rates in regional areas such as Daegu (28.5%), Daejeon (22.2%), Jeonnam (9.7%), and Gyeongbuk (25.8%) remain below 30%. This is why credit rating agencies and securities research centers are warning about construction companies with many unstarted PF projects and a high regional proportion.

Kwon Joon-sung, a senior researcher at NICE Credit Rating, said, "Some construction companies that aggressively expanded their housing business scale during the real estate boom in 2020-2021 have excessive PF contingent liabilities relative to their financial buffer, or have high credit risk due to a large proportion of regional projects," but added, "Corporate bonds maturing in the first half are expected to be refinanced through private placements or financial institution borrowings if refinancing in the public market is difficult, so refinancing itself should not be a problem."

Korea Ratings downgraded the credit ratings of GS Construction and Dongbu Construction in the second half of last year from 'A+ → A' and 'A3+ → A3', respectively. Taeyoung Construction and Shinsegae Construction's rating outlooks were lowered from 'Stable' to 'Negative.' NICE Credit Rating warned of credit risks for Lotte Construction (A+/Negative, A2+), Taeyoung Construction (A-/Stable, A2-), HDC Hyundai Development Company (A/Negative), and GS Construction (A+/Negative, A2+). Among the construction companies monitored by credit rating agencies, Taeyoung Construction applied for a workout. Subsequently, all three credit rating agencies downgraded its credit rating from 'A-' to 'CCC.'

Kim Ki-myung, a researcher at Korea Investment & Securities, pointed out, "The credit market usually shows a strong 'January effect,' but this year it is expected to be more limited than usual," adding, "While the Taeyoung Construction workout application issue will not affect high-grade credits, market avoidance of real estate PF-related sectors such as construction, capital, and securities is inevitable."