Construction companies in Korea are struggling with stressed balance sheets, putting financial institutions exposed to them at risk.
Credit rating agencies are starting to note the trouble as higher interest rates raise the cost of funding, raw materials become more expensive and property sales slow.
The outlook on Lotte Engineering & Construction debt was lowered from A+ stable to A+ negative on Dec. 20 by Nice Investors Service, while that of Taeyoung Engineering & Construction was lowered from A stable to A negative on Dec. 21. The outlook for Hanshin Engineering debt was lowered from BBB stable to BBB negative
Lotte Engineering & Construction is known for the Lotte Castle brand, and Hanshin for the Hanshin The Hue apartment brand.
“The costs for building rose from the rise of raw material prices, including steel and cement,” said Lee Eun-mi, a researcher at the Nice Investors Service. “And the successive rate increases are raising the financial costs.”
The price of steel rebar last June was $1,135 per ton, up 23.5 percent on year.
The Bank of Korea raised the base interest rate from 1.25 percent last January to 3.25 percent in November. It is scheduled to hold another rate-setting meeting next Friday.
Before the liquidity crunch, “the borrowing rate from financial companies was about 5 percent,” said Ko Jin-soon, a PR team leader at Lotte Construction & Engineering. “Now, the rate is far above 10 percent.”
Lotte Construction & Engineering’s debt ratio as of September was 175 percent compared to 122 percent at the end of 2019, right before Covid-19. The debt ratio for Taeyoung rose to 191.7 percent from 179 percent in the same period.
Construction firms say their debt ratio is not excessive, but their contingent liabilities have definitely grown.
Lotte Construction & Engineering’s contingent liabilities for real estate project financing was 5.8 trillion won ($4.6 billion) as of November, four times higher than five years earlier, according to Korea Ratings. Contingent liabilities for Taeyoung grew six-fold in the same period to 2.4 trillion won.
Construction companies usually borrow funds to finance their projects. They initially take out short-term loans and eventually receive project financing from financial institutions as the construction advances.
But it became difficult for them to finance in the short-term after a company related to the developer of Legoland Korea Resort defaulted in September and after an insurer declined to redeem a perpetual bond in November.
To raise funds, Lotte issued 200 billion won in new shares in October. Lotte Chemical and Hotel Lotte bought 173.7 billion won of the issue.
Smaller developers are often hit hard because they normally don’t have deep-pocketed related companies to bail them out and their business is mainly housing sales. The housing market is more sensitive to the economy than the construction of plants, commercial buildings and infrastructure.
Four developers filed for bankruptcy last year as of October, according to the Construction Association of Korea. It is double the number from the previous year.
The bankrupt developers include Wooseok Construction, the sixth largest developer in Chungcheong Province.
Construction troubles are affecting finance.
Real estate project financing loans issued out by credit finance firms, including card and capital firms, was 27.1 trillion won as of September, according to the Bank of Korea last month.
“Housing prices determine the profitability of a project financing,” said Lee Jeong-wook, Director General at Bank of Korea’s Financial Stability Department. “So whether debt will become insolvent will depend on the level of the fall of housing prices.”
Lee added Korea’s financial firms will be able to endure up to a 15 percent housing price fall.
In Seoul, apartment prices fell 4 percent between September and November, according to the Korea Real Estate Board.
“The amount of insolvent debt isn’t yet notable,” said Jeong Hyo-sup, a researcher at Korea Ratings. “But a decline in the apartment sales rate is a sign of debt becoming insolvent.”
A total of 58,000 new apartments were unsold last year as of November, up 23 percent on month.
As sentiment weakens, the government is gradually lifting property restrictions to encourage people to buy a house, but demand hasn’t yet recovered.
“Demand for housing seems difficult to recover in the short run considering the recession and the rise of interest rates,” according to a report from Korea Ratings released in December. “Sales in the construction sector are projected to decline in 2023 as it will become difficult to reflect the increased cost of raw materials in the initial sales price due to the rise in the number of unsold houses.”
BY JIN MIN-JI [[email protected]]