Eye on the prize in Korea's banking sector

The likely privatisation of Woori Financial Group and possible sale of Lone Star’s stake in Korea Exchange Bank could result in the emergence of a Korean megabank this year.

Korean banks plan to get big in 2010. Indeed, this year promises the biggest shake-up in Korea's banking sector since 12 years ago when, during the worst of the Asian crisis, the government closed down a third of the country's merchant banks, nationalised some of the commercial banks and allowed foreign ownership of others. But, rather than retreat, Korean banks are now looking to become megabanks.

It might seem an odd objective when the US "too-big-to-fail" paradigm has suffered such a hammering since the collapse of Lehman Brothers in September 2008. Even the investment bank model, apparently perfected by Wall Street's blue-blooded titans, suddenly held less appeal to Korean regulators who were ushering in a new, permissive financial industry structure under the Financial Investment Services and Capital Markets Act (Fiscma).

One reason the banks are on the megabank push is that it has become tough to make money in an over-crowded domestic market, and it is likely to become harder following the implementation of Fiscma, which will make it easier for securities firms to compete for savings.

As Chanik Park, managing director and head of Korea equity strategy at Morgan Stanley said: "A drop in net interest margins (NIM) from 2005 to 2008 was driven not by market rate movements, but by lending competition and the onset of savings disintermediation."

He doesn't expect NIM (excluding credit cards) to recover to 2005 levels of 2.5%, and said that even a 2% NIM would probably require sizable policy rate hikes and further deleveraging of banks' balance sheets.

Another reason for the push to become bigger is that Korean banks are increasingly looking outward, following their customers as they invest abroad. Local firms' direct investments overseas hit a record high of $10.2 billion in the fourth quarter of 2009, according to the Bank of Korea.

In January, Lee Baek-soon, president of Shinhan Bank, predicted that megabanks will dominate the domestic sector. And government officials also say that Korea needs at least one giant bank to compete in the global financial market. Currently, the country has no bank that figures in the world's top 50 by asset size.

Woori and KEB up for sale

The catalyst is two key divestments that analysts are confident should happen this year. The first is the privatisation of Woori Financial Group, which in February overtook KB Financial Group (Kookmin) as Korea's biggest lender by asset size. The second is the sale by US private equity firm Lone Star of its controversial 51% stake in Korea Exchange Bank (KEB).

Analysts are speculating about which domestic bank will win these prizes, but politics is bound to figure in both sales. There are still fierce parliamentary and public objections to any exit strategy for Lone Star's KEB holding that allows it to walk away enriched, but the state's divestment of its Woori holding should be far less controversial.

The government, through Korea Deposit Insurance Corporation (KDIC), took a 78% stake in Woori after a W7.9 trillion ($6.8 billion at current exchange rates) bailout in the aftermath of the Asian financial crisis. It has talked about divestment before, and sold 5% in June 2007, but now it is serious. Last December, KDIC sold a 7% stake to several investors, and intends to off-load a further 16% in the first half of 2010.

Then, at the beginning of 2010, Jin Dong-su, chairman of the Financial Services Commission, indicated that full privatisation would happen this year, and explicitly said that a merger of Woori with another financial company is possible, because it would raise the value of the firm.

Kookmin was initially touted as the most likely merger candidate. The two lenders' combined assets are more than W600 trillion, which would certainly give Korea a chance to establish a megabank that ranks within the world's top 50. And there would be synergies: while Woori is strong in corporate banking, KB is strong in retail banking.

But now Hana Bank has emerged as the favourite to link up with Woori, simply because it is being left behind. "Hana Bank's small size relative to the three biggest domestic lenders [Woori, Kookmin and Shinhan] raises questions about its long-term viability, so a merger with Woori would make strategic sense," said Steve Lim, J.P. Morgan's Korea chief executive. Hana has assets worth about W169 trillion -- a little over half the size of Woori.

The Korean press reported in February that executives at Woori and Hana are in the process of preparing ideas about a merger. One suggestion is that KDIC sells 8% of Woori in a block trade, and that Woori buys just under 8% as treasury stock. The remaining 50% would then be swapped with Hana shares.

Another possibility is a three-way merger between Woori, Kookmin and Hana -- or even a tie-up with Korea Development Bank (KDB).

KDB seeks deposit base

In October 2009, KDB took a major step towards privatisation when it handed over its role as a state policy bank to a new entity, Korea Finance Corporation (KoFC), and set up a new holding company, KDB Financial Group. Its stated aim is to be among the top 20 corporate and investment banks by 2020.

KDB Financial is expected to push aggressively for acquisitions, in the first instance because it needs a deposit base. A KDB Financial spokesman acknowledged this, saying it would help augment KDB Financial's competitiveness in investment banking.

KEB, the nation's fifth-largest lender, would be a good fit. As J.P. Morgan's Lim pointed out: "KDB needs a bank deposit franchise to secure a low-cost funding source and to get privatised with healthy competitiveness, and this it can achieve from buying KEB."

Otherwise, KDB would have to depend too heavily on wholesale funding, which would be restricting to say the least.

 "Our banks have a large reliance on capital markets and wholesale funding, which was a concern among investors immediately after the Lehman Brothers collapse [in September 2008]," said Shin Je-yoon, deputy minister for international affairs at the Ministry of Strategy and Finance. "As a result, we introduced tighter regulations, including insisting on a move to loan-deposit ratios of less than 100%." Currently, that ratio is about 110%, but Morgan Stanley's Korea bank analysts reckon it should fall below 100% by 2013.

Lone Star chief executive John Crayken recently said he would like to dispose of its 51% controlling stake in KEB this year, having tried unsuccessfully for four years due to legal problems. The private equity firm bought the then distressed bank for a bargain-basement price of $1.2 billion in 2003; it has since been plagued by investigations into alleged violations of laws relating to its purchase.

KEB was set up as Korea's specialist foreign exchange bank in 1967, and still retains a 40% market share of domestic foreign currency transactions. Lone Star tried to off-load its holding to Kookmin in 2006, to HSBC the following year, and in September 2008, Hana and again Kookmin surfaced as possible buyers.

So, it is unlikely that KDB Financial will get a free run at KEB. Kookmin chief executive Kang Chung-won said earlier this year that he is still interested in buying KEB, Hana might bid if a merger with Woori doesn't materialise and the National Agricultural Cooperative Federation (Nonghyup) is also said to be interested.

"A KDB-KEB combination would make good commercial sense for both banks, but a Hana-KEB merger cannot be ruled out. Politics will inevitably have an influence, not least over Lone Star's exit from KEB and the level of profits that the firm will take away," said another Seoul-based investment banker.

It promises to be a busy year -- and no doubt a turbulent one -- for Korea's domestic banks as they fight for local market share and prepare to compete on the global stage.

This article was first published in the March 2010 issue of FinanceAsia magazine. 

¬ Haymarket Media Limited. All rights reserved.
Share our publication on social media
Share our publication on social media