(Bloomberg) -- Investors in few, if any, countries in the world have been burned as badly by the collapse in the commercial real estate market as those in South Korea. Its pension funds, insurance companies and asset managers all plowed billions of dollars into properties across the globe just before the pandemic drove down their value.

But as the losses are tabulated, it is Korea’s brokerages — and especially the smallest of them — that are causing the most angst in Seoul. Regulators at the industry watchdog, the Financial Supervisory Service, are scrutinizing these securities firms particularly closely as they monitor the situation, according to an FSS official who asked not to be identified discussing private deliberations.

Stress tests conducted by the FSS show the financial system is healthy overall, the official said, but the brokerages are generating the most concern now because they took on the most risk in recent years. One international banker, who also asked not to be identified discussing sensitive matters, said that the firms at times seemed not to fully comprehend the danger of the risky loans they were making to property buyers. Their focus was getting as many deals done as possible, the banker said.

Signs of damage to their balance sheets are already emerging. Credit rating company NICE Investors Service estimates that more than 20% of the brokerage industry’s 14.1 trillion won ($10.4 billion) of overseas property exposure is at risk of potential default — a figure that is all but certain to climb as growing numbers of loans and investments start to come due.

While there’s broad consensus among bankers and analysts that the biggest brokerages have sufficient capital to absorb any losses, questions about the health of smaller firms are growing louder. They’re particularly vulnerable because they’ve been buffeted by a second real estate blow — this one at home, where soaring interest rates are sparking defaults on loans tied to all sorts of projects.

“The securities companies were looking for higher yields” and “real estate was usually considered medium risk,” said Cyn-Young Park, an economist at the Asian Development Bank who has studied the Korean financial system.

Park sees some of the brokerages facing a “liquidity issue” as they seek to refinance maturing loans at higher interest rates. “The ones that probably have a bit more of a problem are going to be smaller ones” as well as some individual investors, she said.

The trouble has caught the attention of foreign investors who specialize in distressed situations. Two investors, speaking on the condition they not be identified, said they’re watching for signs of a liquidity squeeze that will allow them to pick up assets on the cheap.

Trouble Signs 

The saga is the latest sign of financial turmoil emerging in the world’s biggest economies following the spike in inflation and interest rates. There was the run on US regional banks in the winter and then, shortly thereafter, the collapse of Credit Suisse Group AG, leaving regulators on high alert for more trouble.

The first big sign of turmoil in Korea came a year ago, when a default by the developer of Legoland Korea triggered a credit crunch. Then this July, the Bank of Korea stepped up liquidity support in the financial system after an increase in soured real estate loans caused a run on a credit union. That same month, the FSS publicly urged brokerages to brace for a prolonged real estate slump and boost their capital buffers.

Securities firms’ net profit plunged 73% in the second quarter from the previous three months, partly due to losses from overseas investments, according to the FSS. With offshore exposure that amounts to 18% of their equity, based on Korea Investors Service data, the risk is that the full impact will only become clear closer to the maturity date on the investments they made.

While Korea is not alone in having placed massive wagers when interest rates were low, its obsession with property poses outsized risks. They were the third-biggest overseas investors in US commercial property last year, according to MSCI Real Assets, going well beyond its clout as the world’s 13th-largest economy.

“The vast majority of their overseas acquisitions went to the office sector,” said Benjamin Chow, head of Asia real assets research at MSCI. Ever since the pandemic sparked a surge in remote work, office-building occupancy rates and rentals have been under pressure in the world’s biggest cities, and this, when added to the higher interest rates, “does not bode well for these assets with refinancing deadlines looming,” he said.

Even the country’s most financially stable firms — those considered too big and well-capitalized to be in any danger — have been saddled with losses on projects.

In 2018, Hana Securities Co. and IGIS acquired Trianon tower in Frankfurt for €670 million ($708 million). It’s now offered for sale for about €350 million, React News reported last month. Hana was also part of a consortium that bought Germany’s The Squaire for almost €1 billion in December 2019. Analysts at S&P estimated its recovery value at just over €570 million earlier this year. A Hana spokesperson said it’s waiting until maturity for The Squaire, while IGIS, an asset manager, confirmed it’s seeking to sell Trianon.  

Mirae Asset Securities Co. has written off 90% of its mezzanine loan used to finance the Goldin Financial Global Centre in Hong Kong, according to a spokesperson. Korean investors also lost control of Dublin office leased to Meta Platforms Inc. this month. 

“Uncertainties in the global real estate market will continue for now,” said Choi Hyun Man, chairman at Mirae Asset Securities, one of Korea’s largest brokers. “For that market, there needs to be one or two years of tolerance,” the company cited him as saying in a forum in London earlier this month.

The central bank said in its financial stability report this week that brokerages with loans and investments coming due within a year should negotiate terms to minimize the negative impact on the local financial system. It urged stronger risk management as those investments tend to be illiquid, and warned of bigger losses should a recovery in the commercial property market get delayed. 

Surging Delinquencies  

Pain, meanwhile, keeps mounting for brokers in the local real estate market. Delinquency rates on property-related loans soared above 17% at the end of June, a near 7 percentage point rise in six months, according to the financial regulator.  

It’s one reason Korean authorities have been on high alert, eager to prevent a repeat of last year’s credit crunch. Just this week, the government said it plans to increase guarantees for short-term property loans as higher interest rates bite. 

Smaller brokerages are more vulnerable to impairments, with a write down of just five local projects enough to push them under water, according to NICE, the credit rating company.  

The global office market is “likely to remain very difficult due to high interest rates and a structural change into hybrid working conditions,” said Shyn Yong-Sang, a director at the Korea Institute of Finance. “Domestic investors have invested heavily via mezzanine loans and equity investments, and the risks are concentrated in certain companies due to the inability to sell down assets.”

--With assistance from Harry Suhartono, Catherine Bosley and Jack Sidders.

(Adds plan to increase guarantees on property loans in third paragraph from the end of the story.)

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