"Distressed PF loans sold, but the risk remains"... Warning of a "sale illusion" in savings banks' normalization-fund sales [fn Market Watch]

[The Financial News] An analysis has found that while savings banks have improved their soundness indicators by selling distressed real estate project financing (PF) loans to normalization funds, substantive credit risk remains. This is because the risk is being transferred to beneficiary certificates as savings banks reinvest in the funds after selling nonperforming loans. In particular, the beneficiary certificates acquired through reinvestment often rank below the original PF loans in repayment priority, raising concerns that further losses could arise during the recovery of distressed assets.
According to NICE Investors Service on the 14th, the ratio of savings banks’ real estate PF exposure to equity stood at 42% at the end of June this year. That was down 99 percentage points from 141% at the end of 2022. The reduction in PF exposure was the largest among major non-bank financial sectors, including securities firms and capital finance companies.
NICE Investors Service, however, pointed out that "a cautious assessment is needed as to whether the improvement in savings banks’ soundness has led to a genuine reduction in risk." This is because savings banks sometimes reinvest in normalization funds when selling distressed PF loans to them.
In such cases, the original PF loans decrease on the books, but savings banks continue to bear the risk of the real estate projects indirectly through fund beneficiary certificates. In other words, a decline in exposure resulting from the sale of loan receivables does not necessarily mean that the ultimate risk of loss has been eliminated.
A more serious issue is that the nature of the risk exposure can change during reinvestment. NICE Investors Service analyzed that beneficiary certificates acquired through reinvestment in normalization funds are often assigned a lower repayment priority than the original PF loans. This means that if the sale of a project site or the recovery of funds is delayed, losses could be greater than if the original loan receivables had been held.
Ahn Su-jin, a senior researcher at NICE Investors Service, pointed out that "savings banks are reinvesting in the funds as they sell PF loans to them, so substantive risk remains even after the sale."
The researcher went on to emphasize that "the beneficiary certificates acquired through reinvestment are often assigned a lower repayment priority than the original PF loans, raising the possibility of additional losses during future asset recovery."
Risk at the PF project sites that remain with savings banks is also still high. Bridge loans accounted for 49% of the total PF exposure of the savings banks assessed by NICE Investors Service at the end of June this year, down only from 55% at the end of 2022. This contrasts with the declines over the same period at securities firms, from 26% to 16%, and at capital finance companies, from 31% to 17%.
Bridge loans are typically provided before a project transitions to main PF financing, for stages such as land acquisition and obtaining permits, and are relatively vulnerable to project delays and a downturn in the housing sales market. Although savings banks’ overall PF exposure has fallen substantially, considerable risk is believed to remain at the project sites still on their books.
Researcher Ahn forecast that "the remaining PF project sites are likely to have relatively weak business prospects, and repeated failed court and public auctions could prolong the recovery of distressed assets." Unsold homes in provincial areas remain unresolved, while the business environment is also becoming more uncertain in the Seoul metropolitan area amid tighter lending regulations and rising interest rates, the assessment noted.
This has prompted calls to consider not only changes in PF loan balances and delinquency rates but also the actual risks and recoverability of beneficiary certificates acquired through reinvestment in normalization funds when assessing savings banks’ credit risk. NICE Investors Service plans to reflect a comprehensive review of trends in the disposal and recovery of distressed assets, asset quality, and changes in capital adequacy in its credit ratings.
[email protected] Kim Hyun-jung Reporter