Fears grow over project financing loans in financial sector

Bad real estate project financing loans are crippling both the financial and construction sectors, with savings banks in fear of being liquidated engaging in a war of nerves with builders to survive.

In addition, bad project financing loans, which had been a problem only for nonmonetary institutions, are also rattling commercial banks.

With the entire financial sector showing signs of being hit by bad project financing loans, expert say financial authorities should ease fears in the financial sector over the short term and conduct restructuring of the construction sector over the long run.

Sambu Construction, which is going through a corporate rehabilitation procedure formerly known as court receivership, is negotiating with its group of large shareholders on the withdrawal of the rehabilitation procedure, provision of a hotel as collateral, and loan extension but an agreement remains elusive, said financial and construction sources Thursday.

Sambu is not the only builder on the brink of bankruptcy. After four leading builders, including World Construction, Jinheung Corp., and LIG Construction, became insolvent this year, fears over a series of bankruptcies in construction are spreading.

Bad project financing loans extended by non-banking financial institutions are making the construction sector, which is reeling from lack of funds, more difficult to stay afloat.

To avoid liquidation, savings banks are retrieving funds from builders that have maturing or overdue loans. This is because the problem with non-performing project financing loans is so serious that saving banks have no room to take care of builders.

According to the Financial Supervisory Service, the balance of project financing loans in non-monetary institutions last year was 27.8 trillion won (25.5 billion U.S. dollars), or 71.8 percent of the balance of project financing loans in commercial banks (38.7 trillion won or 35.6 billion dollars).

Of the amount, savings banks had the largest portion of 12.2 trillion won (11.2 billion dollars).

Default rates are also increasing. The default rate for the financial sector rose from 4.4 percent in late 2008 to 6.4 percent in late 2009 and 12.9 percent late last year. Default rates for securities companies (30 percent), savings banks (25 percent), finance houses (18 percent), and special accounting of the National Agricultural Cooperative Federation (18 percent) were far higher than the financial sector average.

Well-performing commercial banks are also on alert due to bad project financing loans because builders to which they extended loans could go insolvent despite stringent risk management against project financing programs.

An executive in charge of lending at a commercial bank said, “We were surprised by Sambu Construction’s application for the corporate rehabilitation program because it had been considered sound,” adding, “As such, insolvent builders can emerge at any time. This concerns us.”

At commercial banks, the balance of project financing loans is declining, but non-performing project financing bonds rose more than 21-fold from 300 billion won (276 million dollars) in late 2007 to 6.4 trillion won (5.9 billion dollars) late last year. As a result, the share of non-performing project financing bonds to all non-performing bonds rose from 3.9 percent to 25.41 percent over the same period.

With savings banks battling builders for survival, many fear that they could collapse together. This will create a vicious circle of a slowdown in the construction sector, lack of funds in builders, non-performing financial institutions, competition for funds retrieval by banks, and additional bankruptcies of builders.

More worrisome is the collapse of cooperation between construction and finance. Banks said hasty applications for the corporate rehabilitation procedure by construction companies undermine trust between the two sectors.

An employee in charge of lending at another commercial bank said, “If a builder applies for corporate rehabilitation abruptly as Sambu did, we`ll lose trust in the construction sector,” adding, “Trust and credibility are the keys to finance, so the bankruptcy of a company, no matter how small, will create significant aftereffects.”

The construction sector has also made claims. A source at a construction company said, “Banks extended PF loans based on their feasibility assessments, but they want to retrieve loans if the construction sector slows down. This is against what’s right.”

Some in the financial sector blame policy failure for the situation. Many have urged legislation of a law on the promotion of corporate restructuring, but differing opinions between the Financial Services Commission and the Justice Ministry have hampered the legislation.

Others urge a revision to bankruptcy law to prevent hasty applications for the corporate rehabilitation procedure.

redfoot@donga.com