Quaking In Seoul
One by one, South Korea's huge conglomerates keep keeling over. Since January, the Hanbo and Sammi construction and steel chaebol, as these diversified giants are called, have failed under the weight of massive debts. Spirits vendor Jinro and textile giant Dainong are on life support, kept out of bankruptcy only by their creditors. On July 15, the $20 billion Kia Group, which owns Korea's second-biggest auto maker, barely avoided collapse when lenders dismantled it in exchange for a moratorium on debt payments. Kia Chairman Kim Sun Hong was outraged, says one Seoul bank executive. But the group owes $10.7 billion. "We had to do something drastic," the banker says.
Now, Seoul officials are confronting a new dimension of the corporate crisis: the possibility of a meltdown in the banking sector. Korean banks were holding at least $18 billion in dud loans in December. That number is far higher now, and each chaebol failure pushes the major commercial banks closer to the brink. This year alone, lenders have given $24.6 billion--roughly 10% of South Korea's money supply--to the five chaebol that have slipped into insolvency. And Standard & Poor's has now placed five banks on a credit watch. If the massive loans prove uncollectible, the banks' combined shareholder equity could be wiped out. The crisis cries out for a dramatic restructuring of the corporate and banking sectors. But the situation is so bad, and resistance to change still so strong, that reforms now proposed may not be enough.
HIGH RISKS. Little wonder that the mood in Seoul is "fraught with tension and uncertainty," says Han Seung Soo, a former Finance Minister and Deputy Prime Minister. Resolving the crisis will require all the finesse President Kim Young Sam's technocrats can muster. If they go too slowly, the debt mess will haunt South Korea's companies and banks well into the next century. Push too hard, and they could trigger a massive sell-off of real estate, equity holdings, and businesses by cash-strapped banks and chaebol. That, in turn, could set off a deflationary spiral that would push the economy into a recession.
Kim's government is finally taking steps to avert major collapses among the banks. With back-to-back chaebol failures prompting U.S. and Japanese banks to cut credit lines or demand hefty premiums on loans, the Bank of Korea has extended $3.5 billion in emergency foreign-currency loans to domestic banks. And on July 17, the central bank received a request for $1.1 billion in low-interest loans from Korea First Bank, the nation's second-biggest commercial bank, which lent nearly $1 billion to Kia. Korea First is carrying roughly $3.2 billion in nonperforming or risky loans, and it posted a first-half loss of $417 million, the largest in Korean banking history.
The Finance & Economy Ministry may force the bank to restructure--or merge with a stronger bank. "We are trying to avoid the early stages of a bank panic," says Yoon Chong Won, the ministry's assistant director of financial policy.
On July 10, the Finance Ministry also announced new lending restrictions. The guidelines bar banks from lending more than 45% of their capital base to any one chaebol. To discourage high debt levels, they limit tax write-offs on interest payments to companies with debt ratios beyond 500%. They also sweeten other tax write-offs to encourage the chaebol to pay off loans by selling chunks of their estimated $40 billion worth of real estate holdings.
These measures follow years of ineffective financial reform, official meddling in lending decisions, and reckless corporate borrowing. According to the ministry, 170 major Korean companies now have debt-to-equity ratios exceeding 500%. Hanwha, for example, is at 751%, and Ssangyong comes close with 409%. "Over the next three to five years, the Korean economy will have to work off overcapacity in virtually all sectors of industry," says Rhee Namuh, an economist with Dongbang Peregrine Securities.
Given the extent of the banks' exposure, it's hard to see how the new edicts can reverse what decades of sloppy lending have wrought. "These are good rules--and about five years too late," says Raoul Oberman, a senior manager with McKinsey & Co. in Seoul. Other moves are even less inspiring. Seoul lenders have banded together to give cash-strapped companies such as Jinro, Dainong, and now Kia two-month breaks on debt payments as long as they drastically restructure. Kia, for instance, must now sell off 14 subsidiaries and $3.5 billion worth of real estate and other assets to pay off its debts in order to stay out of bankruptcy.
DAMAGED GOODS. Trouble is, these assets will fetch far less for the banks now that Kia is viewed as damaged goods and its assets must be sold off in haste. Worse, the banks are expected to extend fresh loans to Kia as part of the deal--possibly throwing more good money after bad. Indeed, there is scant evidence that Seoul bankers are turning off the cash spigot. When the stock market fell by 26% last year, making equity finance unattractive, companies merely increased their short-term borrowing. Nor have they let up. Korean companies recorded an additional $53 billion in debt during the first quarter, says the Bank of Korea. That's on top of the $845 billion already owed to domestic lenders.
Widespread cronyism in the banking establishment and the government ministries may also stall reforms. Soon after the Kia news broke, Korea First Bank President Roo Shee Yul, a former central bank official, visited an old colleague, central bank Governor Lee Kyung Shik, to request financial help. It's not clear whether his old ties will help. But many in the finance sector worry that if troubled players can use contacts to get preferential treatment, they won't carry out the kind of cost-cutting and belt-tightening that is needed. Insists Kwang Soo Shim, assistant governor at Korea Development Bank: "That era is over."
Kim's government, weakened by political scandal and preoccupied with upcoming December elections, may not be able to rise to the occasion and lead the country out of this mess. Yet until the government stops telling banks what loans to make, until weaker banks merge into stronger ones, and until the chaebol clean up their balance sheets, it's going to be one wild ride.