"Forced to Shoulder 83 Billion for Being One Day Late"... What Was Supposed to Be a 'Lifeline' Has Become a 'Trap': The PF Crisis [Construction Crisis Report]

Construction Companies Trapped by PF Liability
Trust Companies Gain Influence... Profits Secured Just by Providing Guarantees
"PF Should Shift from Loans to Investments"

The reason construction companies are not free from the risk of a wave of bankruptcies stems from the distorted structure of project financing (PF) projects. Financial institutions (which provide funding), developers (which plan projects), and builders (which handle construction) all participate in large-scale construction projects through PF and share the profits. However, the business risk is concentrated on the builders. Even if the developer fails, the builder must take responsibility, and the builder is also held accountable for investment failures by financial institutions. With the introduction of the "completion guarantee system," the burden of rapidly rising construction costs and the accumulation of unsold units has also fallen squarely on the builders.

An executive at a mid-sized construction company ranked around 40th in construction capability stated on the 29th, "It is unreasonable that the developer, who is the principal investor, does not take responsibility and the builder bears the entire burden." He added, "Financial institutions, which are responsible for PF loan risk assessment, should also share a certain portion of the risk as members of the lending syndicate. The sales contract specifies only the developer, builder, and trust company (which manages funds) as parties to the contract. The lending syndicate is not directly responsible due to this, but it cannot be excluded from discussions of responsibility, given the enormous interest income it has earned over the past few years of rising interest rates."

Government Announces 'Solution,' but the Field Still Suffers

In May, the government introduced the "Model Guidelines for Handling PF Loans with Completion Guarantee Commitments" to reduce the burden concentrated on builders. The guidelines included expanding the grounds for construction period extensions and differentiating the proportion of debt assumption. However, they did not address key issues such as construction cost increases or practical loss compensation measures. In particular, the new standards do not apply retroactively to existing contracts, so the burden remains unchanged for mid-sized construction companies that have been involved in PF projects since before the system was implemented.

Angang Construction, ranked 116th in construction capability and which applied for corporate rehabilitation this year, was forced to assume 83 billion KRW in PF debt from Hanseung Logistics, the developer, simply because it missed the completion guarantee deadline by one day at a logistics center construction site. In response, Angang Construction filed for a court injunction to suspend the debt assumption last year, and the court accepted the request, citing that the main cause of the completion delay was administrative processing delays by the city of Ansan.

However, the developer failed to secure tenants for the logistics center and was unable to repay the PF funds. As a result, Angang Construction, as the joint guarantor, was forced to assume the debt. Ultimately, Angang Construction filed for court receivership in February. In the same month, Bumyang Construction, ranked 182nd in construction capability, also incurred 109.8 billion KRW in completion guarantee debt. Regardless of the reason for the construction delay, the builder was required to assume the debt in accordance with its agreement with the lending syndicate.

Distorted PF Structure... "Completion Guarantee Commitment"

The PF system became established in the wake of the Asian financial crisis. Under the pretext of managing debt ratios, a structure was adopted in which the developer acquired the land and the builder handled construction. Before this, large construction companies would directly purchase land and raise construction funds themselves. With the introduction of PF, builders no longer needed to purchase land directly. They did not have to record the massive land acquisition costs as debt, thus maintaining financial soundness. The debt ratio of construction companies is a key metric in credit rating assessments and public project bids, and is considered even more important than profitability indicators such as operating profit.

However, the trap was that the actual business responsibility was shifted to the builders. Most developers were "planning-type corporations" lacking both capital and the ability to assume responsibility. Most of these companies were not in a position to receive the massive PF loans required for construction projects. Financial institutions required "payment guarantees" from the builders. Builders, despite not directly purchasing the land, had to act as sponsors for the developers.

This structure evolved into the "completion guarantee commitment." This means the builder promises to complete the project by the scheduled deadline. If certain requirements are not met, the builder must repay the principal and interest of the PF loan. The builder is also held responsible for delays in completion due to force majeure, such as failed sales, supply chain disruptions, or administrative delays. Lee Moosong, head of new business at the Construction Association of Korea, explained, "The completion guarantee commitment may seem to secure only construction responsibility on the surface, but in reality, it forces the builder to shoulder the entire risk of business failure. Developers take 20-30% profit if the project succeeds, but bear no responsibility if problems arise."

As trust companies entered the PF market, the responsibility of builders grew even greater. After the financial crisis, cases increased in which financial institutions approved loans based on trust company guarantees, and the influence of trust companies grew rapidly in this process. Whereas previously trust companies only managed project funds, their role expanded to include builder selection, construction cost determination, and project structure design. As the role of trust companies grew, the influence of builders gradually diminished. In particular, for small and mid-sized construction companies, it became standard that they could not participate in projects unless they accepted the conditions set by trust companies. In this process, trust companies do not bear responsibility for project failures but still secure stable profits. In addition to fund management fees, they also earn separate income from guarantee fees and other sources.

A red light is on at a traffic signal near an apartment complex. Photo by Asia Economy DB

In this situation, as regional housing sales projects failed, construction companies found themselves in crisis. When units did not sell, developers faced cash shortages, and builders, unable to receive construction payments, halted work. As they failed to complete projects within the completion guarantee period and the lending syndicate moved to recover funds, builders entered workout programs or court receivership. As of May, the number of "malignant unsold" housing units reached 27,013, marking an increase for 22 consecutive months and the highest level in 11 years and 11 months.

However, the greed of builders also contributed to this crisis. By oversupplying the market beyond actual demand, they ended up generating only unsold units. The case of Daegu, which has the largest number of "malignant unsold" units?those that remain unsold after completion?is a prime example. Since 2020, Daegu city has sought to amend ordinances to reduce the floor area ratio of mixed-use residential buildings in commercial areas to less than half, in response to concerns about oversupply. However, opposition from construction companies and local governments prevented the amendment. At that time, the housing supply rate had already exceeded 104%.

Daegu city estimated the appropriate annual demand at 12,500 units for 2018-2027, but the actual number of units released for sale was 25,141 in 2018 and 28,057 in 2019?more than double the estimated demand. Even through 2022, large-scale housing projects exceeding 20,000 units per year continued to be approved. Some, including local construction unions, called for slowing permit approvals to control supply, but Daegu city could not administratively reject projects that met legal requirements. Ultimately, the combination of oversupply ignoring demand, high interest rates, and economic recession caused the regional construction market to collapse rapidly.

"PF Should Shift from Loans to Investments"

Despite these structural problems, PF loans remain virtually the only funding channel for real estate developers. However, as concerns over PF insolvency have grown, financial institutions have effectively shut their doors.

An executive at a major construction company said, "There is talk of new PF supply, but in reality, there is almost none. Most of the PFs coming to market are rollover extensions of existing loans." An executive at a developer added, "Unless it's a high-quality apartment, financial institutions won't even review the loan application."

Experts point out that PF should be reborn as an investment business rather than a simple lending business. They argue that it is more appropriate for investment banks (IBs) to participate in PF and assume some of the capital risk. Currently, the domestic PF market relies mainly on commercial banks (CBs) focused on lending. In a PF structure dominated by lenders rather than investors, the principal and interest must be repaid under any circumstances, so the risk ultimately concentrates on the builder.

Order of Articles in the 'Construction Crisis Report' Series

<1-1> Construction Sites at a Standstill, the Collapse of Day Laborers' Lives
<1-2> "Three or Four More Defaults"... Mid-Sized Builders Targeted for Restructuring
<2-1> What Was Supposed to Be a 'Lifeline' Has Become a 'Trap': The PF Crisis
<2-2> Easing Multi-Homeowner Regulations, Key to Reviving Regional Real Estate
<3-1> "Every Day Is Nerve-Wracking": Subcontractors and Back-End Industries Shaken
<3-2> Even Major Builders Could Not Avoid Wage Arrears
<3-3> LH and Local Governments Also Owe Wages
<3-4> Even the President Has Stepped In... Urgent Need for Vertical Structure Reform
<3-5> The Company That Survived Without Illegal Re-Subcontracting
<3-6> United at Collapsed Sites
<4-1> Foreign Construction Workers Encroaching on Domestic Jobs
<4-2> From 'Regulating Foreigners' to 'Protecting Domestic Workers'
<4-3> The Fundamental Cause of Profitability Deterioration: Frequent Rework