[House Built on Debt]② The Money Party Is Over... Urgent Need for PF Loan Standards

'Additional Liquidity Supply' May Increase Potential Non-Performing Loans
Time for Bold Restructuring to 'Separate the Wheat from the Chaff' Needed

Editor's NoteThe aftermath of Taeyoung Construction's workout application is shaking not only the construction industry but also South Korea's financial sector and capital markets. The decisive cause of Taeyoung Construction's workout application is excessive project financing (PF) guarantees. In an attempt to increase order volumes, PF guarantees were recklessly issued, and as the real estate market froze faster than expected, projects were delayed, making it impossible to repay principal and interest. As real estate PF defaults materialized, not only the secondary financial sector such as savings banks, capital companies, and securities firms but also the primary financial sector froze. Thirteen years ago, during the savings bank crisis, the issue was considered limited to mid-sized construction companies focused on housing projects and savings banks, but the recent PF default crisis has a much broader impact. Secondary financial institutions such as Saemaeul Geumgo, capital companies, securities firms, and savings banks actively participated in real estate PF loans, and trust companies also participated under the condition of responsibility completion guarantees for mid-sized construction companies with low credit ratings, spreading PF loan risks across the financial sector. With Taeyoung Construction, ranked 16th in contract ranking, faltering, there are concerns about a chain bankruptcy of mid-sized construction companies that increased orders and PF loans during the real estate market upswing. The recurring threat of real estate PF defaults to our economy is examined through the opinions of construction, finance, and capital market experts to find fundamental causes and constructive alternatives to prevent recurrence.

'The Money Feast' Is Over... Need to Establish PF Loan Standards

During the long era of low interest rates and real estate boom, bridge loans from the secondary financial sector surged significantly, and the commissions earned by securities firm employees who intermediated funds were enormous. This is also why PF loans increased rapidly. Much of the money that flowed into the real estate market during the liquidity-rich period now remains only as debt, and those who orchestrated the money feast do not take responsibility. Experts unanimously agree that more organized and systematic management of the entire real estate PF market is necessary.

Professor Lee Yoon-hong of Hanyang University Graduate School of Real Estate Convergence said, "(When PF loans were arranged) securities firm executives received commissions ranging from 2 billion to 6 billion KRW, and associates and assistants also received commissions in the hundreds of millions of KRW," adding, "At the point when defaults increased, securities firm employees should return their commissions. Going forward, I believe commissions should be paid to securities firm employees only after PF loans are repaid."

Professor Lee advised, "Securities firms should revise related regulations to prohibit handling PF loans exceeding 100% of their capital, and regulations requiring project operators to contribute at least 20% of project costs should be implemented. Also, if a construction company’s debt ratio exceeds 250%, it should be classified as a risk group and restricted from winning private projects."

Former Overseas Construction Association Chairman Lee Geon-gi criticized, "It makes no sense for securities firms not to invest in stocks but to invest in real estate. It should be seen as playing money with real estate. Allowing securities and capital companies to engage in real estate PF was one of the causes of excessive bubbles in the real estate PF market."

Bold Restructuring Needed... "Time to Separate the Wheat from the Chaff and Save the Competitive"

Experts advise that to escape the imminent crisis of chain bankruptcies among construction companies, the government should create an environment where rapid ownership changes can occur. They suggest encouraging project operators to sell PF default projects at a discount.

Professor Yang Jun-mo of Yonsei University’s Department of Economics said, "Rather than providing more liquidity now, bold restructuring is needed, such as creating an environment that allows quickly closing down poorly judged projects."

He predicted that distinguishing between sound projects and default projects?the 'wheat from the chaff'?will determine the future direction of the PF default crisis.

Criticism has also been raised that current government measures are liquidity supply-oriented and superficial. A market bank official said, "A market expert should lead a task force (TF) related to real estate PF, and an accurate checklist to separate the wheat from the chaff is necessary."

Kim Jung-joo, a research fellow at the Korea Construction Industry Research Institute, said, "For practical separation of the wheat from the chaff, all stakeholders including major creditors, local governments, the Ministry of Land, Infrastructure and Transport, the Financial Services Commission, and the Ministry of Strategy and Finance must participate to establish standards. Funding support should be provided for parts that can be saved, and for difficult parts, third parties should acquire and proceed or acquire only land to reorganize projects."

Experts diagnosed the current real estate PF default crisis not as a 'liquidity crisis' but as a 'credit crisis.' They are concerned that the government's additional large-scale liquidity programs for construction companies and PF projects may only increase the scale of defaults.

A construction industry insider said, "If projects could normalize with short-term liquidity supply, it could be seen as a liquidity crisis, but the current situation is a credit crisis where no matter how much liquidity the government supplies, repayment is impossible."

A securities firm real estate PF officer said, "Bridge loan projects that are difficult to secure feasibility are extending deadlines, but difficult projects should dispose of collateral through auctions and sales, allowing investors with financial power to acquire and restructure projects, thus opening a distressed debt market." He added, "Although there will be a significant short-term market shock, for projects with poor feasibility, the scale of distressed debt at major financial institutions only grows over time."

From Putting Out the 'Urgent Fire' to Fundamental Treatment... Need for Long-Term Measures

Experts commonly emphasize that in the long term, strengthening capital requirements for project operators and improving PF loan evaluations must be implemented. They advise inducing structural improvements across the entire construction industry, including real estate PF.

First, the scale of equity capital input by project operators (developers and promoters) must be expanded. When equity capital input increases, project operators face greater risk from reckless project execution, enabling selective resource allocation. It is also expected to reduce the risk of risk transfer to financial institutions and contractors during real estate market downturns.

Professor Yang said, "Like foreign countries, it is necessary to strengthen the capital power of project operators. The current crisis fundamentally stems from people with nothing starting project operators. The fact that projects can be executed by just pulling money through bridge loans means the lack of capital itself increases the possibility of default."

A senior official from a real estate specialized asset management company said, "Strengthening equity capital requirements for project operators is not a difficult issue. Industry practices just need to change; many already have thick equity, especially when foreign capital is involved in domestic development projects, the equity stakes are very substantial." He added, "Since the risk has been properly assessed this time, financial institutions will likely demand higher equity ratios going forward."

Improving PF loan evaluations by financial companies is also an important issue. Research fellow Lee Bo-mi of the Korea Institute of Finance said, "As the primary lenders, financial companies need to establish a system to evaluate the success of projects based on the projects themselves. During boom periods, strict monitoring was not necessary as fund recovery was not problematic, but going forward, it is crucial for financial institutions to develop their inherent expertise in assessing project feasibility."

There are also suggestions to increase post-sale projects in the construction market. Research fellow Lee advised, "During boom periods, buyers could enjoy capital gains by purchasing pre-sale rights, but in a sluggish market, such expectations do not hold. Although consumers may initially resist switching to post-sale, buying completed homes is more stable, and as experiences accumulate showing that pre-sale rights can lead to losses, a balance point will be found."

Kim Hyo-sun, Senior Real Estate Specialist at NH Nonghyup Bank, also advised, "The high proportion of apartments and predominance of pre-sales have exposed the market to significant risks. It is necessary to make the sales market more transparent and gradually increase the proportion of post-sales in the long term." Kim added, "Post-sales naturally allow only financially capable parties to proceed with projects, preventing the current situation where projects are undertaken without capital, causing financial instability due to debt."