The risk of contingent liabilities related to the responsibility construction management type land trust of real estate trusts is becoming a reality, leading to downgrades in credit ratings. As construction companies falter and construction costs soar, more responsibility construction projects are failing to meet their commitments to complete buildings within the scheduled construction period, leading to increased losses for the trusts. Real estate trusts provide credit enhancement, promising to cover losses for lending financial institutions if they fail to fulfill their responsibility construction commitments through responsibility construction land trust guarantees.
According to NICE Credit Rating on the 3rd, the credit rating agency conducted a regular evaluation of real estate trusts in the second half of last year and downgraded the short-term credit rating of Shinhan Asset Trust from A2 to A2-. The long-term credit rating outlook for Korea Trust was also lowered from BBB Stable to BBB Negative. Korea Ratings also downgraded the commercial paper credit rating of Shinhan Asset Trust from A2 to A2- last month.
The downgrade of Shinhan Asset Trust's short-term credit rating is attributed to the realization of risks associated with contingent liabilities related to responsibility construction, which has led to an increase in net losses. Yoon Gi-hyun, a senior researcher at NICE Credit Rating, explained, "In the case of Shinhan Asset Trust, a significant net loss during the current period occurred due to increased bad debt-related expenses, the deterioration of asset soundness due to the faltering of responsibility construction establishments in the real estate development market, and the expectation that the significantly reduced capital adequacy compared to the past will persist for the time being."
Regarding Korea Trust's long-term credit rating outlook, the likelihood of the company's size being reduced due to a decrease in new orders for responsibility construction land trusts has had an impact. Additionally, declining profitability due to increased bad debt expenses and funding costs, coupled with the realization of contingent liabilities related to responsibility construction establishments, has also been reflected in this credit rating evaluation.
Even with no changes in credit ratings, most real estate trusts are facing increasing burdens due to the deterioration of responsibility construction establishments. The real estate trust industry recorded a net loss of 227.7 billion won due to bad debt burdens associated with responsibility construction obligations until the third quarter of last year. The return on assets (ROA) also deteriorated to -3.3%.
Due to low sales rates and surging construction costs, projects for which funding is needed have exceeded their project financing lending limits, leading to an increase in the self-financing of funds. Consequently, the lending from trust accounts (money borrowed by trusts from their proprietary accounts for the purpose of financing project costs) rose by 37.9% to 6.6931 trillion won on September 6 from 4.8551 trillion won at the end of the previous year.
As the lending to responsibility construction establishments increases, the fixed assets of real estate trusts grow, leading to a deterioration in asset soundness. This lending is generally ranked lower in repayment hierarchy and is invested in establishments with deteriorated business viability, resulting in classification as fixed assets for soundness assessments.
The outlook for the real estate trust industry remains bleak this year. As the real estate market recession continues, an increase in trust account lending and expanded bad debt burdens related to responsibility construction establishments is anticipated. Yoon, the senior researcher, noted, "As the downturn in the real estate market persists mainly in local areas, additional funding inputs and bad debt burdens to meet the deadlines for responsibility construction projects continue to exist."
The legal disputes arising over the calculation of damages for establishments that failed to meet their responsibility construction commitments are also increasing the uncertainty for real estate trusts. While real estate trusts argue that overdue interest should be considered as substantial damages for the establishments not fulfilling their responsibility construction, lenders are demanding the return of principal and overdue interest. It has been reported that the principal and interest of some establishments greatly exceed the average equity capital of trusts, which is 400 billion won.
Yoon, the senior researcher, emphasized that "As disputes arise over the scope of responsibility construction obligations of real estate trusts, the responsibility construction land trust market is expected to significantly weaken," and predicted that "The growth trend of operating profits for real estate trusts, which had been expanding mainly in responsibility construction land trust projects, will slow down." He added, "If real estate trusts fail to create new revenue streams in the future, their scale may shrink."