Guaranteed Completion Becomes a Boomerang... Trust Companies’ Financial Stability Shaken by Surging Provisions for Bad Debts [Real Estate AtoZ]

Increase in Provisions for Bad Debts on Real Estate Trust Companies' Loan Receivables
Up 24.3% in Just Two Quarters
Driven by Guaranteed Completion Project Acquisitions and Financial Support to Construction Firms
"Financial Stability Management Burden Expected to Persist"

Apartment complex in downtown Seoul. Photo by Yonhap News

The financial structure of real estate trust companies has deteriorated rapidly. Industry experts point to the obligation of guaranteed completion as the main cause. As the construction market slump continues and construction companies struggle with liquidity shortages, trust companies that have assumed the obligation of guaranteed completion have been providing financial support, which is now coming to a head. With the likelihood of not receiving proper payments from construction companies increasing, provisions for bad debts have ballooned.

According to data compiled by the Korea Financial Investment Association on January 7, provisions for bad debts on loan receivables at 14 real estate trust companies stood at 2.4792 trillion won as of the third quarter of last year. This represents a 24.3% surge compared to 1.9941 trillion won in the first quarter of the same year. Provisions for bad debts on loan receivables refer to the amount that trust companies recognize in advance as losses for funds they may not be able to recover. The increase in provisions for bad debts indicates that the volume of receivables held by trust companies with a low likelihood of recovery is steadily growing.

The industry points out that the reason trust companies are holding hard-to-recover receivables is due to the acquisition of guaranteed completion projects. To secure profits, trust companies have entered into guaranteed completion contracts, under which they must either complete the project themselves or compensate for losses if the construction company fails to finish within the agreed timeframe. However, as the construction market has worsened, financial burdens have increased and project completion has become more difficult, leading to a significant rise in cases where trust companies provided funding to construction companies using their own capital around 2024. The loans extended at that time are now becoming problematic.

This situation is evident in the sharp increase in the proportion of provisions for bad debts in trust account loans among loan receivables. Among trust account loans-where trust companies lend their own capital to construction companies and others-the amount of provisions for bad debts that are difficult to recover rose from 1.9797 trillion won in the first quarter of last year to 2.4527 trillion won in the third quarter, a 23.9% increase. During the same period, total trust account loans grew from 7.8548 trillion won to 8.8355 trillion won, up 12.5%. The amount of unrecoverable loans increased at a greater rate than the overall increase in loans extended.

The burden from guaranteed completion obligations is also reflected in various damage claim lawsuits. In December last year, KB Real Estate Trust disclosed that it had been sued for damage claims of 5.2 billion won and 28.8 billion won, respectively, for failure to fulfill guaranteed completion obligations related to a mixed-use facility in Nonhyeon-dong, Namdong-gu, Incheon, and a logistics center development project in Gimpo.

Korea Ratings stated, "With sluggish sales performance persisting, the burden of managing financial stability is expected to continue, considering delays in the recovery of existing trust account loans and increased provisions for bad debts," adding, "The ongoing litigation risk associated with guaranteed completion-type development trusts also remains a factor weighing on financial stability."

The industry sees little chance of improvement in the short term. However, while trust companies exposed to guaranteed completion obligations are expected to continue facing risks, those not exposed are projected to gradually expand their business scope by increasing new project acquisitions. An industry insider commented, "Companies tied to guaranteed completion obligations find it difficult to take on new projects due to risk, whereas those that have already resolved such issues are in a different position. Some trust companies that have managed their risks from early on are now believed to have bottomed out and are showing signs of recovery."