Korean government mandates Cho Hung GDR

The Korean financial sector stages a return to the international equity markets as Cho Hung is mandated and KorAm sends out an RFP (Request for Proposals).

In a step, which further underlines the Korean government's determination to push through and accelerate bank privatization, a first mandate is awarded for Cho Hung Bank and its prospective deal size doubled to roughly $1 billion. Within the next couple of days the Korea Deposit Insurance Corporation (KDIC), is expected to announce that it has selected Credit Suisse First Boston, JPMorgan and UBS Warburg as the three global co-ordinators of a GDR sale.

Having initially planned to sell 15% of Cho Hung to international equity investors, the government is now said to be considering divesting up to 35%. Given that KDIC currently owns 80.05% of the bank, such a move will see it cede majority control and trigger its $500 million exchangeable bond of December 2001. Launch is expected either late March or early April.

For CSFB and UBS Warburg, the mandate represents a new marker in a long-standing relationship with Cho Hung and underscores both banks' continuing domination of the Korean investment banking scene. UBSW, for example, has led Cho Hung's only international equity offering to date - a $180 million GDR of 1996. It was also one of the three lead managers of the government's December exchangeable alongside Goldman Sachs and JPMorgan.

CSFB's relationship also extends back to 1996. What was then a BZW team (later acquired by CSFB), handled the GDR sale alongside Warburg.

In 1999, the bank was also mandated for a $1 billion equity re-capitalization with Salomon Smith Barney. However, this deal never got off the ground after the equity markets were shut by a disastrous GDR offering from Hanvit Bank, spiraling NPLs across the entire banking sector and a stock price which tumbled below W5,000 par value.

For JPMorgan, the award of the Cho Hung deal is a major coup and one that will send a worrying signal to its nearest competitors. Having historically been extremely strong across M&A and debt, the bank's investment banking platform has been consistently let down by its equity operations. But with the recent award of high profile mandates in Malaysia and Indonesia, the bank is starting to build up a much-needed track record.

Winning the mandate also vindicates the original proposal to sell stakes in Cho Hung and Woori Financial Holdings via an exchangeable bond. Widely slated as being completely unworkable at the time of launch, the deal's subsequent success stands testament to the skill of the bank's influential Korean investment banking head, Steve Lim.

Indeed, although during roadshows the government continually told investors that it would follow-through with bank privatization, many were said to have been extremely sceptical that a QPO (Qualifying Public Offering) would ever occur. Most assumed that the four-year deal would remain a straight debt instrument and not be triggered into an exchangeable by the QPO, or at least not until the two-year put.

Yet throughout the structuring process, the government is said to have insisted on retaining the flexibility to initiate the privatization programme as soon as it could and re-coup some of the W155.3 trillion ($118.5 billion) it has spent re-capitalizing the banking system since 1999.

On January 25, it gave further details of its programme. A MoFE official stated that the government would sell 15% of Cho Hung during the first half of 2002 and then a further 15% to 20% to a strategic investor during the second half. Should no strategic investor be found, a block of 10% to 15% would be sold to domestic institutions instead. The remaining 40% to 45% would then be sold in stages after 2003.

Around the same time, however, a non-deal roadshow led by ABN AMRO highlighted investors' concerns that such a large overhang would weigh down the stock price. Taken alongside Korea's persistent difficulties securing strategic investment in its banking sector, the government is consequently said to have decided to scrap stage two and sell a large block of equity in one shot.

Cho Hung currently has a market capitalization of $2.879 billion based on a share price of W5510 (Wednesday's close) and 679.08 million outstanding shares. It has a free float of $574 million, or 19.95.%. Based on these figures, the new deal stands to raise $863 million at the lower end of the government's range (30% divestment) and $1.15 billion at the top end (35%).

Under the terms of the exchangeable, a QPO in Cho Hung is triggered if the stock reaches a liquidity threshold of $1 billion. The new deal will almost certainly achieve this and ECM bankers believe the exchangeable will see a migration from fixed income to convertible holders.

As one notes, "The deal is currently bid at 104%, about three points above its bond floor. We'll probably start to see a migration once it gets up to about six points and in a recent research report, Goldman commented that once there a QPO occurs, it'll be worth 110%."

Year-to-date, the stock is up 33.09%. This year's outperformance matches last year's, when the stock was one of the Kospi's star performers, climbing steeply during the last three months from a September 17 low of W1,700.

Although analysts have a mixed view of its near-term performance, most agree that Cho Hung is still undervalued relative to its peers. While, for example, Kookmin Bank is trading on a price-to-book ratio of 1.7 times, Cho Hung currently stands at 1.2 times, just shy of the 1.3 to 1.4 average of the better quality Korean banks.

The main drag on its share price has been the need to increase provisioning. It currently reports an NPL level of 3.3%, down from 10.2% at the end of 2000 and a capital adequacy ratio of 10.4%, up from 9.8% a year earlier.

But as one analyst comments, "We feel the situation at Cho Hung will be fully normalised by 2003 because gross operating profit is increasing rapidly and this will enable the bank to fully provision in a way that it wasn't able to before without wiping out its equity.

"However," he adds, "the bank still needs to increase its provisions this year. Although it's reporting a reserve cover ratio of 90%, its loan classification is relatively loose relative to other quality banks. Its exposure to Hynix and the Ssangyong group, for example, is still classified as precautionary rather than as an NPL. Were it to use the strict classification of its peers, its reserve ratio would fall to about 50% against their 65% average."

On the positive side, analysts note that Cho Hung - Korea's third largest bank by deposits - is the Republic's best performing bank in terms of net interest margins. During 2001, it achieved a 4% level compared to 3.4% at Kookmin, Korea's largest retail bank. Analysts say that this can attributed to Cho Hung's monopoly right to hold deposits generated through the courts.

Local observers are also confident that a large GDR offering will be well received despite the sector's troubled past and investors' memories of a $1 billion equity re-capitalization for Hanvit Bank in September 1999. Priced at a steep 21% discount to the stock's W8,250 close, the deal nevertheless managed to rapidly sink as the Daewoo group collapsed and it became apparent that Hanvit's capital structure appeared to be little more than a black hole.

Since then, there have been no international equity offerings from the Korean banking sector.

"Korea has done the best job of any country in Asia when it comes to restructuring the banking sector," one local observer argues. "The government has injected trillions of won, been very aggressive in reducing NPLs and imposing strict capital ratios. It's now starting to enjoy the fruits of this success and the momentum is all positive going forwards from here."

KorAm seeks equity funding

One of Korea's most conservatively provisioned banks (95% reserve cover ratio) is also hoping to raise $200 million to $300 million through a GDR offering. An RFP has been sent to six banks - CSFB, Goldman Sachs, JPMorgan, Merrill Lynch, Salomon Smith Barney and UBS Warburg - although observers report that JPMorgan decided not to submit.

Previously KorAm had been hoping to persuade the government to let it raise about $150 million via a hybrid tier 1 issue because it did not want to kill its return on equity by issuing common or preferred stock. The bank remains keen to boost tier 1 equity, however, because it has been aggressively increasing its asset base through expanded consumer lending and a fast growing credit card business.

At the end of 2001, the bank reported a provisional CAR of 11.15%, up from 8.67% at the end of 2000. The group's aggressive stance in cleaning up its balance sheet follows the sale of a 50.1% stake to a Carlyle and JPMorgan led consortium at the end of 2000. Prior to this, the bank had been badly hit the collapse of its founding shareholder, the Daewoo group, to which it had W1.2 trillion in loans outstanding.

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