South Korea’s five major banks are struggling to cope with the fallout from their risky investments in foreign real estate projects, amid a global economic slowdown and rising interest rates.
Banks’ exposure to real estate project financing
Real estate project financing (PF) is a type of loan that is secured by the future cash flow of a property development project, such as an office building, a hotel, or a theme park. PF loans are typically long-term and have high interest rates, reflecting the uncertainty and complexity of the projects.
According to the Bank of Korea, the total value of PF loans extended by the five major banks – KB Kookmin, Shinhan, Woori, Hana, and NH Nonghyup – reached 28.3 trillion won ($24.8 billion) as of June 2023, up 3.8 trillion won from the end of 2012. Of this amount, 12.8 trillion won ($11.2 billion) was invested in overseas projects, mainly in the US, Europe, and Southeast Asia.
The banks’ exposure to overseas PF loans increased by 8.7 trillion won ($7.6 billion) over the same period, accounting for 45 percent of their total PF loans. This reflects the banks’ strategy of diversifying their portfolios and seeking higher returns in foreign markets, where the demand for PF loans was strong due to the booming real estate sector.
Risks and challenges of overseas PF loans
However, the banks’ overseas PF loans have also exposed them to various risks and challenges, especially in the wake of the COVID-19 pandemic and the subsequent economic downturn. Some of the factors that have increased the likelihood of defaults and losses for the banks are:
- The prolonged impact of the pandemic on the tourism and hospitality industries, which have been the main targets of the banks’ PF loans. For example, KB Kookmin Bank invested 1.2 trillion won ($1 billion) in the Legoland Korea project, which was scheduled to open in 2022 but has been delayed indefinitely due to the pandemic. The bank has already provisioned 300 billion won ($262 million) for the project, but it may face further losses if the project fails to materialize.
- The rising interest rates in the US and Europe, which have increased the borrowing costs and debt burdens for the project developers. The US Federal Reserve and the European Central Bank have both signaled their intentions to tighten their monetary policies in response to the inflationary pressures and the economic recovery. This means that the project developers will have to pay more interest on their PF loans, which may affect their profitability and cash flow.
- The regulatory and legal uncertainties in some of the foreign markets, which have created obstacles and disputes for the project developers and the banks. For instance, Shinhan Bank invested 600 billion won ($525 million) in a hotel and casino project in Vietnam, but the project has been stalled due to the lack of a gaming license from the Vietnamese government. The bank has also been involved in a legal battle with the project developer over the repayment of the loan.
Banks’ measures to mitigate the losses
The banks have been taking various measures to mitigate the losses from their overseas PF loans, such as:
- Strengthening their risk management and monitoring systems, to identify and prevent potential problems and defaults. The banks have also increased their provisions and reserves for their PF loans, to reflect the deteriorating asset quality and the expected losses.
- Restructuring and refinancing their PF loans, to extend the maturity and lower the interest rates for the project developers. The banks have also been seeking to sell or securitize some of their PF loans, to reduce their exposure and improve their liquidity.
- Diversifying and rebalancing their PF portfolios, to reduce their reliance on overseas projects and focus on more stable and profitable domestic projects. The banks have also been expanding their PF lending to other sectors, such as renewable energy, infrastructure, and logistics, which have less volatility and more growth potential.
The banks have expressed their confidence that they can overcome the challenges and recover from the losses, as they believe that most of their overseas PF projects have long-term value and prospects. However, they also acknowledge that they need to be more cautious and selective in their PF lending, as the global economic and financial environment remains uncertain and complex.
