Financial Authorities Begin Oversight of Savings Banks... Pressure on Real Estate PF Auction and Foreclosure [Why&Next]

Request for Submission of Emergency Capital Expansion Plans
Same for Status of Todamdae Sites Related to Real Estate PF
Market Conditions Not Easy, Expected Exposure Increasing
Concerns Over Deterioration of Soundness
Authorities Want to Solve Supply Issues Through Auctions and Public Sales
Industry Reluctant... "Too Low Prices Mean Big Losses"

The Financial Supervisory Service (FSS) has requested savings banks to submit capital expansion plans due to concerns over potential defaults in real estate project financing (PF). The authorities state that this is a routine procedure to prepare for any unforeseen circumstances. However, there is analysis suggesting that the FSS is pressuring savings banks, which have many land-secured loans at the bridge loan stage, to activate auctions or public sales of related project sites. The savings bank industry is reluctant, arguing that even setting aside the recovery of investment funds, selling invested projects at too low a price would increase losses.

The FSS recently demanded that savings banks that recorded losses last year submit emergency capital expansion plans and soundness management plans by the end of this month. These plans are expected to include each savings bank’s financial structure management strategies and how they will raise emergency capital. The authorities explained that this is to prepare for any emergency situations.

However, this is interpreted as a measure beyond routine procedures to address the real estate PF default problem. The FSS has also requested the submission of the status of real estate PF land-secured loan projects by the 17th. It appears they will review the scale of real estate PF-related projects held by savings banks and examine their viability. Most of the real estate PF-related claims held by savings banks are in the form of bridge loan land-secured loans. A bridge loan refers to short-term borrowing by developers for initial development funds such as land acquisition before construction begins. In the early stages, developers borrow money from secondary financial institutions at high interest rates, and once the project viability and asset value are confirmed, they borrow funds from primary financial institutions. This borrowing is called the main PF.

On the 5th, Lee Bok-hyun, Governor of the Financial Supervisory Service, held a back briefing regarding the Saemaeul Geumgo illicit loan suspicion incident after the signing ceremony for the cooperation agreement between the telecommunications and financial sectors to strengthen the response and cooperation against financial crimes harming the public, held at the Korea Federation of Banks in Jung-gu, Seoul. Photo by Jo Yong-jun jun21@

However, the current PF market has deteriorated in viability compared to when the bridge loans were executed due to the real estate market downturn and rising construction material costs. Last year, amid rising bond yields and financial market instability, PF issues were deferred with interest-only payments, but financial authorities have started full-scale PF market restructuring this year. To resolve bridge loan issues, land or project implementation rights must be sold at prices much lower than the purchase or book value. Lowering land or project implementation rights prices significantly reduces cost burdens and improves project viability. In this process, a new developer takes over the project, and losses for existing financial institutions involved in the bridge loans are inevitable.

Savings banks have made efforts such as disposing of non-performing bridge loans, but the expected exposure to real estate PF risks may still reach up to 4.8 trillion KRW. According to NICE Credit Rating, as of the end of last year, the real estate PF exposure of 16 major savings banks was 7.7 trillion KRW, down 1.4 trillion KRW from 9.1 trillion KRW at the end of 2022. Of this, the main PF decreased by 165 billion KRW and bridge loans by 1.1755 trillion KRW. However, assuming a slow recovery in the real estate market, the estimated loss on real estate PF exposure for these 16 savings banks is projected to be between 2.6 trillion and 4.8 trillion KRW.

Ultimately, the FSS’s position is that the real estate PF problem can only be resolved if non-performing projects are quickly normalized through auctions and public sales and real estate supply proceeds smoothly. The FSS plans to complete individual or sectoral meetings this week with major commercial banks, mutual finance institutions, specialized credit finance companies, savings banks, and insurance companies. The main topic of these meetings is measures to activate auctions and public sales. To promote the cleanup of non-performing projects, the existing three-tier classification of 'Good (normal asset soundness classification) - Normal (watch list) - Deterioration Concern (substandard or below)' is being subdivided into four tiers: 'Good - Normal - Deterioration Concern - Doubtful Recovery.' The minimum provision rates for PF loans by project will also be divided into normal (2%), watch list (10%), substandard (30%), and doubtful recovery (75%), aiming to induce cleanup and restructuring of non-performing projects through auctions and public sales. Lee Bok-hyun, Governor of the FSS, emphasized, “It is appropriate for the ownership of projects with poor profitability and bridge loans to change.” He also revealed that they are preparing temporary incentives for financial institutions that make efforts on main PF or viable projects, or restructuring based on funding supply.

The authorities are also concerned that leaving the real estate PF problem unresolved could harm the soundness of savings banks. According to the ‘Financial Stability Report’ released by the Bank of Korea on the 28th of last month, stress tests were conducted under scenarios where all high-risk real estate PF projects become non-performing and where such defaults spread to other projects. As a result, the savings banks’ BIS (Bank for International Settlements) capital adequacy ratio (as of last September) fell from 14.1% to 12.6% in the first scenario. In the second scenario, it dropped to 11.4%. The BIS ratio is an indicator of capital soundness, with lower values indicating weaker soundness.

The financial authorities routinely recommend a BIS ratio of 9-10% or higher for savings banks. The prompt corrective action threshold for management improvement recommendations is a BIS ratio below 8% for banks with total assets over 1 trillion KRW, and below 7% for those under 1 trillion KRW. If the BIS ratio falls below 5%, management improvement requests can be made, and if it falls below 2%, management improvement orders can be issued. Such orders may include a six-month business suspension.

The authorities are also paying close attention to the rise in the ratio of non-performing loans classified as substandard or below. This ratio represents the proportion of bad loans overdue by three months or more among total loans, with the financial authorities’ recommended threshold at 8%. Last year, the average substandard or below non-performing loan ratio for 79 savings banks surged to 7.72%, approaching the recommended threshold. This was a 3.64 percentage point increase from 4.08% in 2022. The rise in this ratio occurred not only in small savings banks but also in medium and large ones. Pepper Savings Bank, ranked sixth in asset size, recorded 12.86%, and SangSangIn Savings Bank, ranked ninth, recorded 15.05%, both exceeding 8%. Major savings banks affiliated with financial groups, such as KB Savings Bank (10.11%), are in a similar situation.

The savings bank industry is reluctant to accept the authorities’ pressure regarding real estate PF. They say that even if they offer nearly half the asset price, private management companies demand even lower prices. Some believe it is better to extend maturities until the real estate market recovers rather than suffer large losses by rushing into auctions or public sales. A senior industry official said, “There is practically no market,” and added, “While savings banks need to bear losses, they believe that 20-30% of asset prices is excessive.” Another official said, “The authorities want to clear things quickly, but many savings banks think it’s enough to wait just six months or a year.”