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Asia-PacificMay 2 2004

Return to profit

Park Sang-soo reviews the banking sector in South Korea, as financial institutions work to reduce the mountain of bad debt.
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Years of toiling to clear their balance sheets of dud assets appear to have paid off for South Korean banks. They are now in a much better position to withstand the failures of lumbering business groups known as chaebol.

The banks’ asset quality has improved significantly, thanks to massive write-offs of bad loans, while the economic situation has remained favourable for lenders.

However, the South Korean banks now have to deal with bad loans from individuals. After the 1997 financial crisis, Korean banks shifted more of their lending business towards consumers and small and mid-sized firms, often without looking closely into their creditworthiness. Their strategic move was in tune with the South Korean policymakers’ thinking that boosting private spending could offset a drastic fall in overseas demand.

Record figures

Borrowing costs were kept at rock-bottom levels and a range of tax incentives were offered. As a result, household loans jumped sharply, reaching a record Won483,000bn ($418.4bn) at the end of last year, up 5.7% on the previous year, according to data from the Bank of Korea. The figure contrasts sharply with the Won294,000bn and Won352,000bn of 2000 and 2001, respectively.

Unfortunately, the number of defaulting consumers also hit a record of 3.83 million in February, despite a series of government efforts to bring the figure down. Sensing that the credit boom may dampen the economy, regulators forced banks and credit card issuers to adopt more stringent criteria. But it was too late.

Consequences

Bad debts incurred by households and corporations at the 19 banks rose by Won3500bn to Won18,600bn in 2003, as more households and credit card holders defaulted on debt payments. Overdue credits rose to 2.62% of banks’ Won709,000bn of outstanding loans at the end of last year, from 2.33% a year earlier.

Banks wrote down or disposed of bad loans totalling Won31,700bn last year, but a larger amount of new loans totalling Won35,200bn turned sour.

Chohung Bank, which was taken over by Shinhan Financial Group, had the highest bad loan ratio of 4.8% at the end of 2003, compared with 3.8% at the end of 2002. Kookmin Bank, South Korea’s biggest commercial lender, had a bad loan ratio of 3.6% at the end of last year, up from 2.9% a year earlier, after it assumed control of credit card assets from subsidiary Kookmin Credit Card in September last year.

However, the real costs to the economy and financial institutions may be larger than estimated, says Koo Kyung-hae, a banking analyst at Hanwha Securities in Seoul.

Losses arising from the ballooning bad debts eroded banks’ income statements, as most lenders had to share the financial burden.

The latest data from the Financial Supervisory Service show that Kookmin Bank and other South Korean lenders had a 63% decline in combined earnings last year to Won1860bn. This was due to increased provisions against household debts and loans given to SK Networks, formerly known as SK Global, and LG Card, South Korea’s biggest credit card issuer.

In 2003 alone, the banking sector set aside a total of Won2770bn in provisions against loans to SK Networks and LG Card, and Won8190bn against overdue household loans and credit card payments, which eroded banks’ bottom lines.

However, the banks’ pre-provisioning earnings showed a healthy growth of 12.9% to Won16,900bn, driven in part by continuing favourable interest margins (despite the lower interest rate environment). The combined net profit of the eight major commercial lenders reached Won425bn in 2003, a drastic drop from Won2890bn in profits a year earlier.

Of the eight major commercial banks, only four – Woori Bank, Shinhan Bank, KorAm Bank and Hana Bank – remained in the black last year, with other rivals suffering big losses.

Profit drivers

Woori Bank, a unit of Woori Financial Group, racked up Won1,330bn in net profits last year, following Won780bn in profits a year earlier. This was due largely to the parent holding company’s decision to consolidate all credit card operations in its sister company.

Shinhan Bank also enjoyed Won476bn in net profits last year, compared with Won596bn in 2002, as it was more cautious than its competitors about the credit card business. Its credit card operation was spun off from the bank last June.

Hana Bank’s net profits for 2003 increased to Won517bn from Won327bn in 2002, despite a big surge in credit cost for exposure to SK Networks and LG Card. This was mainly because its credit card exposure was relatively small. Kookmin Bank, South Korea’s largest commercial bank, suffered Won753bn of losses last year, compared with the Won1300bn of net profits banked in 2002. Chohung Bank also remained in the red last year with Won966bn in net losses following Won586bn in losses in 2002.

Korea Exchange Bank, which was acquired by a US-based Lone Star Fund last year, suffered Won214bn in losses last year, up from Won113bn in losses on the previous year.

Korea First Bank, owned by US-based Newbridge Capital, shifted into Won13.5bn in losses last year from Won102bn of profits a year earlier, while KorAm Bank, which was acquired by Citigroup, posted Won46.2bn in profits last year, down from Won260bn in profits in 2002.

Asset quality

In addition to combating the sharp rise in overdue household loans and credit card payment, the South Korean banks had to deal with the financial woes at LG Card. As concerns over deterioration in asset quality as a whole in the credit card sectors loomed, investors shunned debts offering by credit card issuers. Rising unpaid bills by customers at LG Card and other credit card companies has forced credit card issuers to seek more funds from their parent companies and affiliates, and bailouts from creditors.

LG Card had a loss of Won5600bn last year, after writing off overdue payments from defaulting customers. The loss compares with a profit of Won350.4bn in 2002.

Earlier in March, LG Card’s eight main creditors agreed to extend the maturities on Won2000bn in emergency loans offered in November last year by year-end to give the card company time to revive its business.

Creditors, led by the state-run Korea Development Bank, have been managing the card issuer on behalf of the creditors after swapping billions of won of debts for equity.

“When its liquidity, capital base and profitability are taken into consideration, LG Card’s viability is still in the dark,” notes Lee Jun-jae, a banking analyst at Dongwon Securities in Seoul. “In the short term, additional capital injection is necessary, and market confidence in the prospects for the card firm’s profitability improvement should follow.”

Positive outlook

Most banks are forecasting a sharp increase in their profits this year, as they set aside sufficient provisions against bad loans and expect an economic upturn to help them rein these in.

Mirae Asset Securities estimates that commercial banks will rack up Won5800bn in profits this year on the back of sales of bad loans and improvement in business conditions.

“Their profits based on fundamental improvement will likely be possible after the third quarter of the year,” forecasts Han Jeong-tae, a banking analyst at Mirae Asset Securities.

No guarantees

Banking sector prospects are not guaranteed, however. The after effects of the consumer credit crisis and the continued concerns over household indebtedness and rising credit risk from exposure to small and mid-sized companies may continue to weigh down the sector.

Credit card operations are widely expected to remain in the red before moving back to break-even in the fourth quarter at the earliest, which means the banking sector may have to post additional provisions on their credit card operations. Recently released economic data also indicates that a sharp consumption recovery is not likely.

The South Korean economy, after expanding by 7% in 2002, grew 3.1% last year, mostly owing to falling private spending and lacklustre corporate spending. However, an export-oriented growth policy managed to pull the country out of a recession in the second half of last year.

The central bank’s forecast is that the country’s economy may grow more than 5% this year. However, the current political impasse over North Korea means the possibility of prolonged economic uncertainties cannot be ruled out.

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