Overhaulin'

Empty apartments and bad loans

Summary: News Analysis As banks began lending to builders based on credit and not the merits of individual projects they set the stage for a rise in deliquency A malady is spreading through Korea s banking system bad financing loans for construction projects Last month alone the government injected 2 8 trillion won $2 4 billion in public funds into savings banks troubled by project financing loans At 61 savings banks where insolvent bonds related to project financing were cleared up by the state run Korea Asset Management Corporation a memorandum of understanding was recently concluded to require them to improve their fiscal structures These institutions may have escaped serious harm but alarms are already ringing in other parts of the financial sector These financing loans rely on expected cash flow from large projects such as new buildings Even though domestic financial institutions take on huge risks by issuing them they typically accept that risk because of the immense profits that can be raked in when the project is completed Recently however a large number of construction firms have begun filing for bankruptcy or become unable to manage their mounting debt amid a stagnant property market That has left the banks that lent the cash in an equally difficult position According to the Financial Services Commission as of the end of last year there were a total of 82 43 trillion won in outstanding project financing loans in Korea of which 50 96 trillion won were issued by commercial banks and 11 81 trillion won by savings banks Delinquency on these loans is also rising In the first three months of this year the delinquency rate for such loans at commercial banks soared from 1 67 percent to 2 9 percent in March after already rising 0 6 percentage points in the previous 12 months The rate at savings banks is much higher above 10 percent though it has fallen since the end of 2008 Just over two weeks ago police raided the headquarters of major consumer institution Woori Bank for alleged fraud in connection with project financing loans worth 380 billion won The former manager of real estate loans at Woori allegedly received 2 8 billion won from a construction firm in the form of consultant s fees in exchange for providing the loans And this wasn t the first such fraud case to arise In June this year an employee at Kyongnam Bank a regional branch of the Woori Bank s parent Woori Financial Group allegedly forged a loan document to expand project financing loans for a specific company causing massive losses To keep these institutions from facing insolvency financial authorities recently examined 17 local banks including the nation s largest Kookmin Bank to check the status of their project financing loans Although the watchdog concluded that project financing loans at commercial banks were not as risky as those at savings banks they also warned that in absolute terms they still presented a significant potential problem Troubled property loans were the primary cause of the massive losses posted by Korea s major financial groups in the second quarter of this year In fact in the second quarter net profits at domestic commercial banks plummeted by more than 60 percent or 2 1 trillion won on quarter and 35 percent or 700 billion won on year The weak performances were blamed on an increase in reserve capital to guard against potential losses a move recently demanded by the government KB Financial Group lost its title as the nation s No 1 banking group by asset value to Woori Financial Group after posting a net loss of 335 billion won from April to June The erstwhile market king had capital reserves estimated at 1 5 trillion won a major contributor to its dethroning With the FSS recently inspecting the banking sector across the board KB Financial Group temporarily set aside a large amount of capital reserves in provision against potential losses related to project financing said Kim Eun gap a researcher with NH Investment Securities This shows exactly how bad the quality problem with project financing loans is Still KB s earnings in the second half of 2010 aren t expected to get any better according to market analysts KB Financial Group has the highest portion of household loans among commercial banks and has high portions of construction related project financing loans and commercial property loans said Suh Young soo a researcher at Kiwoom Securities With the downtrend in real estate prices gaining speed the worsening of its health in loans is inevitable Yet there isn t much to celebrate at the new leader Woori Financial either That group reported a net loss of 40 6 billion won in the second quarter because of mounting bad debt provisions for companies undergoing restructuring and construction related project financing loans It was the first time Woori had posted a net loss since the last quarter of 2008 shortly after the outbreak of the global financial crisis Instead it was Shinhan Financial Group the nation s No 3 financial services company which was the real winner in the second quarter posting a net profit of 588 6 billion won Combined with its first quarter net profit Shinhan raked in 1 37 trillion won in the first half of this year more than what it earned in all of 2009 Analysts attributed Shinhan s strong performance to its preemptive risk management skills In fact Shinhan wasn t a main creditor bank for any of the 16 construction companies that the government announced would have to undergo restructuring at the end of June However Shinhan was the exception not the rule and financial authorities have begun to grow concerned not only about banks but about insurance companies as well According to the Financial Supervisory Service all insurance companies life and non life saw the value of their outstanding project financing loans rise by more than 100 billion won on year to 5 4 trillion won as of the end of May In particular outstanding construction related project financing loans at Korea s major life insurance companies excluding Samsung Life Insurance expanded by nearly 30 percent to 3 6 trillion won at the end of May this year from 2 8 trillion won a year earlier Meanwhile Samsung Life Insurance the nation s No 1 life insurer by asset value was the only one in the industry to reduce its exposure to these loans cutting their debt in this category more than 50 percent to 800 billion won on year at the end of May from 1 7 trillion won a year earlier In the non life insurance sector Samsung Group s affiliated insurer Samsung Fire Marine Insurance departed from project financing altogether with its exposure down from 77 billion won at the end of May last year to zero in May 2010 But other non life insurance companies expanded their project financing loans by nearly 40 percent from 720 billion won to 1 trillion won in the same period In fact non life insurers saw their outstanding project financing loans rise even more than life insurers Analysts say the firms dove into project financing to make up for sagging earnings in one of their core businesses car insurance The companies car insurance loss ratio which compares total losses paid out in claims plus adjustment expenses to the total earned premiums recently surged indicating lower profitability It appears that some insurance firms have aggressively expanded their project financing loans to increase returns on their assets said an industry insider who warned of a growing threat of more defaults An FSS official who asked to remain anonymous said he believed that mounting project financing loans at insurance companies had been driven by commercial and savings banks attempting to divest themselves of the risky debt Insurance companies believe the FSS official said that they are insulated from the added risk because project financing loans account for a tiny portion of their total assets and because they chose only healthy projects But a soaring delinquency ratio on these loans especially those handed out by non life insurers raises the possibility that they may have been wrong The delinquency rate on loans in the non life insurance sector nearly doubled to 11 1 percent as of the end of March this year from 6 4 percent a year earlier That increase is nearly four times the one seen at banks in the same period 2 9 percent Unfortunately this intractable problem is unlikely to be solved quickly as conditions on the domestic housing market continue to deteriorate After the global financial crisis the number of unsold apartments has soared on a stagnant property market and because of that real estate developers and construction firms which depend on selling new apartments to pay back their loans eventually found themselves in a difficult situation where they couldn t even pay the principal said Lee Hyun seok a professor at the graduate school of real estate studies at Konkuk University The problem began when financial firms started giving out loans based on construction firms credit instead of the business value of the specific projects they were going to carry out Lee explained In a bullish real estate market construction firms would have no trouble paying back their loans However with the number of unsold apartments rising cash conditions at builders have worsened Commercial banks or savings banks that sold loans to construction firms based on trust will be exposed to risk when the loan delinquency ratios at those construction companies rise Lee said Jeong Chan woo a researcher at Korea Institute of Finance pointed out that unlike foreign countries Korea has no large sized developers in that smaller real estate developers can only take out loans by having construction firms stand surety To tackle the problem some experts have suggested the establishment of a new regulator to take charge of business deals among public institutions construction investors such as real estate developers and financial investors such as banks A business agreement or changes in a business contract in this area are highly likely to spark controversy and adjustments in development plans must be reviewed broadly Thus an entity that can oversee these three way deals is needed said Lee Hyun ah a researcher with the Construction Economy Research Institute of Korea KIF researcher Jeong also underlined the need to form a new assessment system for the real estate development business in order to provide objective information about construction projects to financial institutions The easing of real estate market regulations was also recommended by one executive in charge of project financing loans at a local commercial bank who wished to remain anonymous Self recovery in the property market would be most ideal he said However if that s not an option the easing of real estate market regulations by the government can be a direct solution to this problem By Jung Jae yoon jyj222 joongang co kr Copyrights ⓒ JoongangIlbo Joins com All rights reserved News Analysis As banks began lending to builders based on credit and not the merits of individual projects they set the stage for a rise in deliquency A malady is spreading through Korea s banking system bad financing loans for construction projects Last month alone the government injected 2 8 trillion won $2 4 billion in public funds into savings banks troubled by project financing loans At 61 savings banks where insolvent bonds related to project financing were cleared up by the state run Korea Asset Management Corporation a memorandum of understanding was recently concluded to require them to improve their fiscal structures These institutions may have escaped serious harm but alarms are already ringing in other parts of the financial sector These financing loans rely on expected cash flow from large projects such as new buildings Even though domestic financial institutions take on huge risks by issuing them they typically accept that risk because of the immense profits that can be raked in when the project is completed Recently however a large number of construction firms have begun filing for bankruptcy or become unable to manage their mounting debt amid a stagnant property market That has left the banks that lent the cash in an equally difficult position According to the Financial Services Commission as of the end of last year there were a total of 82 43 trillion won in outstanding project financing loans in Korea of which 50 96 trillion won were issued by commercial banks and 11 81 trillion won by savings banks Delinquency on these loans is also rising In the first three months of this year the delinquency rate for such loans at commercial banks soared from 1 67 percent to 2 9 percent in March after already rising 0 6 percentage points in the previous 12 months The rate at savings banks is much higher above 10 percent though it has fallen since the end of 2008 Just over two weeks ago police raided the headquarters of major consumer institution Woori Bank for alleged fraud in connection with project financing loans worth 380 billion won The former manager of real estate loans at Woori allegedly received 2 8 billion won from a construction firm in the form of consultant s fees in exchange for providing the loans And this wasn t the first such fraud case to arise In June this year an employee at Kyongnam Bank a regional branch of the Woori Bank s parent Woori Financial Group allegedly forged a loan document to expand project financing loans for a specific company causing massive losses To keep these institutions from facing insolvency financial authorities recently examined 17 local banks including the nation s largest Kookmin Bank to check the status of their project financing loans Although the watchdog concluded that project financing loans at commercial banks were not as risky as those at savings banks they also warned that in absolute terms they still presented a significant potential problem Troubled property loans were the primary cause of the massive losses posted by Korea s major financial groups in the second quarter of this year In fact in the second quarter net profits at domestic commercial banks plummeted by more than 60 percent or 2 1 trillion won on quarter and 35 percent or 700 billion won on year The weak performances were blamed on an increase in reserve capital to guard against potential losses a move recently demanded by the government KB Financial Group lost its title as the nation s No 1 banking group by asset value to Woori Financial Group after posting a net loss of 335 billion won from April to June The erstwhile market king had capital reserves estimated at 1 5 trillion won a major contributor to its dethroning With the FSS recently inspecting the banking sector across the board KB Financial Group temporarily set aside a large amount of capital reserves in provision against potential losses related to project financing said Kim Eun gap a researcher with NH Investment Securities This shows exactly how bad the quality problem with project financing loans is Still KB s earnings in the second half of 2010 aren t expected to get any better according to market analysts KB Financial Group has the highest portion of household loans among commercial banks and has high portions of construction related project financing loans and commercial property loans said Suh Young soo a researcher at Kiwoom Securities With the downtrend in real estate prices gaining speed the worsening of its health in loans is inevitable Yet there isn t much to celebrate at the new leader Woori Financial either That group reported a net loss of 40 6 billion won in the second quarter because of mounting bad debt provisions for companies undergoing restructuring and construction related project financing loans It was the first time Woori had posted a net loss since the last quarter of 2008 shortly after the outbreak of the global financial crisis Instead it was Shinhan Financial Group the nation s No 3 financial services company which was the real winner in the second quarter posting a net profit of 588 6 billion won Combined with its first quarter net profit Shinhan raked in 1 37 trillion won in the first half of this year more than what it earned in all of 2009 Analysts attributed Shinhan s strong performance to its preemptive risk management skills In fact Shinhan wasn t a main creditor bank for any of the 16 construction companies that the government announced would have to undergo restructuring at the end of June However Shinhan was the exception not the rule and financial authorities have begun to grow concerned not only about banks but about insurance companies as well According to the Financial Supervisory Service all insurance companies life and non life saw the value of their outstanding project financing loans rise by more than 100 billion won on year to 5 4 trillion won as of the end of May In particular outstanding construction related project financing loans at Korea s major life insurance companies excluding Samsung Life Insurance expanded by nearly 30 percent to 3 6 trillion won at the end of May this year from 2 8 trillion won a year earlier Meanwhile Samsung Life Insurance the nation s No 1 life insurer by asset value was the only one in the industry to reduce its exposure to these loans cutting their debt in this category more than 50 percent to 800 billion won on year at the end of May from 1 7 trillion won a year earlier In the non life insurance sector Samsung Group s affiliated insurer Samsung Fire Marine Insurance departed from project financing altogether with its exposure down from 77 billion won at the end of May last year to zero in May 2010 But other non life insurance companies expanded their project financing loans by nearly 40 percent from 720 billion won to 1 trillion won in the same period In fact non life insurers saw their outstanding project financing loans rise even more than life insurers Analysts say the firms dove into project financing to make up for sagging earnings in one of their core businesses car insurance The companies car insurance loss ratio which compares total losses paid out in claims plus adjustment expenses to the total earned premiums recently surged indicating lower profitability It appears that some insurance firms have aggressively expanded their project financing loans to increase returns on their assets said an industry insider who warned of a growing threat of more defaults An FSS official who asked to remain anonymous said he believed that mounting project financing loans at insurance companies had been driven by commercial and savings banks attempting to divest themselves of the risky debt Insurance companies believe the FSS official said that they are insulated from the added risk because project financing loans account for a tiny portion of their total assets and because they chose only healthy projects But a soaring delinquency ratio on these loans especially those handed out by non life insurers raises the possibility that they may have been wrong The delinquency rate on loans in the non life insurance sector nearly doubled to 11 1 percent as of the end of March this year from 6 4 percent a year earlier That increase is nearly four times the one seen at banks in the same period 2 9 percent Unfortunately this intractable problem is unlikely to be solved quickly as conditions on the domestic housing market continue to deteriorate After the global financial crisis the number of unsold apartments has soared on a stagnant property market and because of that real estate developers and construction firms which depend on selling new apartments to pay back their loans eventually found themselves in a difficult situation where they couldn t even pay the principal said Lee Hyun seok a professor at the graduate school of real estate studies at Konkuk University The problem began when financial firms started giving out loans based on construction firms credit instead of the business value of the specific projects they were going to carry out Lee explained In a bullish real estate market construction firms would have no trouble paying back their loans However with the number of unsold apartments rising cash conditions at builders have worsened Commercial banks or savings banks that sold loans to construction firms based on trust will be exposed to risk when the loan delinquency ratios at those construction companies rise Lee said Jeong Chan woo a researcher at Korea Institute of Finance pointed out that unlike foreign countries Korea has no large sized developers in that smaller real estate developers can only take out loans by having construction firms stand surety To tackle the problem some experts have suggested the establishment of a new regulator to take charge of business deals among public institutions construction investors such as real estate developers and financial investors such as banks A business agreement or changes in a business contract in this area are highly likely to spark controversy and adjustments in development plans must be reviewed broadly Thus an entity that can oversee these three way deals is needed said Lee Hyun ah a researcher with the Construction Economy Research Institute of Korea KIF researcher Jeong also underlined the need to form a new assessment system for the real estate development business in order to provide objective information about construction projects to financial institutions The easing of real estate market regulations was also recommended by one executive in charge of project financing loans at a local commercial bank who wished to remain anonymous Self recovery in the property market would be most ideal he said However if that s not an option the easing of real estate market regulations by the government can be a direct solution to this problem By Jung Jae yoon jyj222 joongang co kr Copyrights ⓒ JoongangIlbo Joins com All rights reserved

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