Bad building loans overshadow a rebound in bank earnings

Korean banks are expected to post improved earnings for the third quarter, but the size of the profits will hinge on provisions for sour property-linked loans, analysts said yesterday. 

Leading financial services groups Woori Finance Holdings and KB Financial Group are expected to post profits in the July-September period after suffering losses earlier, according to FnGuide, a financial information provider. 

Woori Finance is projected to post around 451 billion won ($388.5 million) in net income, reversing a net loss of 41 billion won in the second quarter. KB Financial Group will report an estimated 500 billion won in earnings after losing 335 billion won in the April-June period, it added. 

Analysts said the improved performance of Korean banks is mainly because some have benefited from the one-off sale of equity stakes. 

Woori Finance and No. 3 industry player Shinhan Financial Group are likely to post about 200 billion won and about 100 billion won in one-time profits, respectively, from the sale of stakes in Hynix Semiconductor and Daewoo International. 

The forecast came as the net income of Korean banks fell in the second quarter, hit by massive reserves related to corporate restructuring and distressed property loans. 

Market analysts said the size of their third-quarter earnings will be affected by the amount they set aside in additional provisions for possible defaults in project financing (PF) lending. PF loans were extended mainly to builders on the basis of expected cash inflows from their construction projects. 

The Financial Supervisory Service is in the process of introducing guidelines to tighten the standard of reserves for PF lending. Local banks may have to put aside funds worth 19 percent of property-linked loans as reserves for builders evaluated as ailing and in need of corporate restructuring. 

"Local banks will inevitably have to set aside more reserves related to sour PF loans. The size of their third-quarter earnings may miss the market consensus," said Lim Il-sung, an analyst at Shinyoung Securities. 

Analysts also estimate that Korean banks' net interest margins (NIMs), a gauge of profitability, are likely to fall in the third quarter, compared with three months earlier, as market rates have not risen as expected. 

Local banks' lending rates are largely linked to the return on the 91-day certificates of deposit (CDs). Despite a July rate hike by the Bank of Korea, the rate on CDs rose marginally. 

The FSS said NIMs stood at 2.31 percent in the second quarter, down from 2.4 percent in the first quarter. 

"As the central bank is seen as hiking the key rate only once more within this year, local banks' NIMs are not likely to sharply recover," said Lee Hyeok-jae, an analyst at IBK Securities. 

The BOK unexpectedly froze the rate at 2.25 percent for the second straight month in September on concerns about the flagging global economy.

In July, it raised the borrowing costs from a record low 2 percent, ending the 16th consecutive month of a stand-pat run

Home Equity Lines of Credit: The Next Looming Disaster

A previous article of mine briefly discussed the madness of borrowing through home equity lines of credit (HELOC) during the bubble years.Now is a good time to take an in-depth look at these second liens and the dangers they pose for the housing market and the large banks.

A Brief Explanation of HELOCs

A HELOC is quite similar to a business line of credit and has some similarities to a consumer credit card as well. Using the residence as security, a homeowner is given a line of credit with a prescribed limit upon which the borrower can draw at any time.

The homeowner receives a draw period of anywhere from five to ten years when funds can be drawn. During this draw period, the borrower is usually required to pay interest only. The rate is adjusted monthly and is pegged to the prime rate. The repayment period is typically ten to twenty years. The monthly principal payment is usually the outstanding balance at the end of the draw period divided by the number of months in the repayment period.

Because qualifying standards were based primarily on the equity in the home, HELOCs became nearly irresistible in those states where prices were rising rapidly in 2004-2005. Homeowners discovered that their home had actually become a money tree which they could shake almost at will.

Madness of HELOC Lending During the Bubble Years

Aided by the seemingly limitless desire of banks to lend money, homeowners opened an incredible number of HELOCs during the bubble years of 2004-2006.

Nowhere was the madness of HELOC borrowing more astounding than in California. During the two key years of 2004 and 2005, a total of 1.43 million HELOCs were originated in California just for the purchase of homes according to figures received from CoreLogic.

Wait a minute, you say. That's more than the total number of homes sold in California during these years. Correct. A total of 1.25 million existing single family homes were purchased in California in 2004-2005 according to the California Association of Realtors.

At first, these California HELOC numbers may be a little puzzling.However, they make sense when you consider the speculative mania that occurred during the bubble years. In my earlier article about investor speculation, there was an example of caravans filled with out-of-state speculators looking to buy investment properties in Austin. One was a young Californian who had sold a few of his Phoenix investment properties so he could roll his profits into Austin homes.

This is what thousands of HELOCs were used for in California. In 2004-2005, borrowers would take out a purchase HELOC to buy investment properties in other hot markets such as Las Vegas and Phoenix. While the loans were recorded as California HELOCs because the borrower's property was in California, the purchased home was actually in another state. CoreLogic provided the following HELOC origination numbers for California.