Increased Funding and Business Structure Stability... Financial Industry Risk Level Assessed to Decline
Business Contraction Expected Mainly in Securities and Capital Companies
Banks and Insurance Companies Anticipate Business Expansion and Revenue Diversification through Participation in Long-Term Rental Housing Projects
Comprehensive Reform of Securities Companies' New NCR, the Starting Point of Real Estate PF, Needed
Structural Improvements Needed to Resolve Mismatches in 'Funding Operation and Procurement' Periods
The government’s institutional improvements aimed at transforming the structure of the real estate project financing (PF) market are expected to enhance the stability of funding and business structures and reduce risks across the financial industry. However, analyses suggest that due to strengthened regulations, PF businesses centered around securities firms and capital companies may experience some contraction. Additionally, following this institutional improvement, there are calls for a comprehensive overhaul of the securities firms’ new net capital ratio (NCR), which was the starting point of real estate PF and has not been recognized for its effectiveness, as well as structural improvements to resolve mismatches between fund operation periods and funding periods.
On the 22nd, NICE Credit Rating Agency evaluated in a report on the government’s 'Real Estate PF Institutional Improvement' that the direction of this institutional improvement would help increase the stability of the funding structure and resolve various exposed issues. However, it also mentioned concerns about the contraction of PF businesses in the secondary financial sector and the need for additional structural improvements. The main points of the government’s institutional improvement are ▲ raising the PF operator’s equity ratio to the 20% range ▲ strengthening PF feasibility assessments ▲ fostering Korean-style developers.
Senior Researcher Lee Yeri explained, "Stabilizing the funding and business structures will mitigate financial and business risks of development projects while enhancing responsiveness to rapidly changing real estate environments. As feasibility assessments for PF loans are strengthened, PF screening standards and soundness can be reinforced, and with the establishment of a PF monitoring system, transparency in the PF market will improve, positively impacting risk management."
However, she predicted a temporary reduction in real estate PF funding supply. Although the government proposed 'REITs' as an alternative, it was assessed to have limitations. Researcher Lee said, "REITs have many advantages over existing developers in terms of scale and risk management, but since REIT investments have not yet fully settled domestically, it is necessary to observe how much REIT utilization can contribute to real estate PF funding supply."
While the risk level of financial companies will decrease and risk management capabilities will improve, some negative impacts are expected as real estate businesses contract. Especially in the secondary financial sector, including securities, capital, real estate trusts, and savings banks, where real estate PF-related income has been significant, it is anticipated that related performance will be affected in the short term as the real estate PF market contracts.
In the securities industry, it is analyzed that bridge loan arrangements will shrink and competition to secure main PF underwriting rights may intensify. Above all, non-comprehensive financial investment firms, which have relatively weaker sales capabilities, have secured main PF underwriting by providing guarantees and loans at the early stages of projects, so securing main PF underwriting may become more difficult. If PF investments are made in the form of equity investments rather than existing loans or contingent liabilities exposure, a higher risk value must be applied, which may dampen related investment sentiment.
Capital companies, which currently face relatively fewer regulations related to real estate PF, may experience significant business contraction if additional regulations are introduced. In contrast, savings banks, already subject to strong regulations, are expected to be less affected by additional regulatory measures. Real estate trusts are also expected to see a decline in related performance due to the contraction of PF businesses.
Banks and insurance companies are analyzed to have potential for business expansion and revenue diversification through participation in long-term rental housing projects. Senior Researcher Dong Youngho said, "Banks and insurance companies have a small proportion of real estate PF business in their portfolios, so the negative impact from related business contraction will be limited. Since risk-weighted assets and provisioning regulations for PF loans by equity ratio are already applied, additional regulatory impacts are expected to be minimal."
NICE Credit Rating Agency also advised that additional institutional improvements, such as a comprehensive overhaul of securities firms’ new NCR, should follow. It is judged that the change in the regulatory capital ratio calculation method from the old NCR to the new NCR in 2016 loosened capital regulations, leading the securities industry to massively enter the real estate PF market, which became the starting point of real estate PF issues.
What financial authorities originally expected from introducing the new NCR was the expansion of traditional investment banking (IB) and overseas business, but securities firms have focused their capabilities on easier real estate development projects. They greatly expanded guarantees in addition to direct credit extensions and actively created development projects, causing the overall scale of real estate PF to balloon.
It was also pointed out that the maturity mismatch between the real estate development project period and the funding period needs to be resolved. Real estate development projects typically take 3 to 4 years, whereas funding periods are very short, ranging from 3 to 6 months. Structurally, maturity mismatches will inevitably continue to occur.
Senior Researchers Lee Yeri and Dong Youngho explained, "As the scale of real estate PF increased due to the new NCR, financial authorities prepared supplementary measures such as adjusting risk weights for securities firms’ real estate PF exposures, but these were not fundamental solutions. To resolve the maturity mismatch between PF operation and funding, institutional improvements are needed to lengthen the funding structure of real estate PF compared to the current state."
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