South Korea’s financial authorities and banks are tightening credit ratings for construction firms by including project financing risks and liquidity to identify restructuring needs amid rising bankruptcies and financial instability.
The financial authorities and creditor banks in S. Korea have decided to include the real estate project financing (PF) contingent liabilities, sales rates, and operational fund stability of construction companies in this year’s credit rating process. The aim is to determine whether such companies will undergo restructuring.
Credit rating is a system where creditor banks classify companies into four grades, ranging from A (normal) to D (restructuring target), based on debt ratios and other criteria. Companies rated C to D will undergo a corporate workout or corporate reorganization procedure. Corporate workout refers to the financial rescue of a firm that is outside formal bankruptcy and insolvency law.
Typically, creditor banks review the credit ratings of companies that have a credit limit of 50 billion won ($36.9 million) or more on an annual basis. Failure to this requirement may result in penalties from creditors, such as loan collection. Due to the increasing number of construction companies dealing with PF contingent liabilities or liquidity crises, many of them are expected to be targeted for restructuring.
The financial authorities made it clear that credit ratings for construction companies will now take into account the riskiness of PF loans and liquidity issues, among other factors. To determine ratings, the size of PF loans, the risk of contingent liabilities, average sales rates, the ratio of cash-like assets, and the stabilization rate of working capital will be evaluated.
The stabilization rate of working capital is a measure of how well a company manages its operating funds through long-term borrowing. This assessment aims to identify construction companies that have high PF loan contingent liabilities, lack cash equivalents, and rely primarily on short-term borrowing to fund operations. These companies could be targeted for restructuring.
Previously, the corporate credit rating was determined based on five factors: industry risk, business risk, management risk, financial risk, and cash flow. Construction companies were only evaluated based on these criteria without considering other relevant factors such as PF loans, sales rates, or the safety of working capital.
This year, there is a growing concern about the possibility of mass bankruptcies among S. Korean construction companies due to PF loans. This has led to calls for project restructuring from financial authorities and creditor banks, and as a result, a stricter evaluation process has been put in place.
Corporate credit ratings are typically conducted annually between April and May, with the final results being announced towards the end of the year. Predictions from financial and industry experts suggest that a significant number of construction companies will be rated C to D in this year’s assessment, which could lead to restructuring. This is due to the poor financial situations of several construction companies.
According to an analysis by the Bank of Korea, financial institutions’ exposure to real estate PF loans came out to be $98.2 billion by the end of Sept. 2023. Out of which, high-risk exposure amounted to $4.3 billion and medium-risk exposure to $15.3 billion.
The size of PF Guarantee of an obligation held by 15 construction companies with valid credit ratings was $20.7 billion as of the end of Sept. 2023, according to Korea Credit Rating. This was an increase of $8.8 billion in three years from $11.9 billion at the end of 2020. However, if contingent liabilities arising from PF project failures materialise, it could weaken the financial strength of construction companies
During the same period, the proportion of listed construction companies with liquidity concerns increased to 16.7% from 11.6% in 2022, and the proportion of companies with excessive debt also rose to 28.8% from 28.4% in 2022.
