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Asia-PacificNovember 6 2006

Local competition sparks drive for diversification

Competition among South Korea’s financial institutions is intensifying, and consolidations are still on the cards. Local giants such as Shinhan Bank are looking to neighbouring markets for opportunities. Karina Robinson reports.
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South Korea’s Shinhan Financial Group is planning to increase its foreign earnings substantially to diversify its sources of income away from the fiercely competitive domestic market, even as it integrates LG Cards, the credit card company it bought several months ago. The financial group is the second largest by assets in South Korea, and the holding company for Shinhan Bank.

“Since the [Asian] currency crisis, Korean banks have tried to seek means for diversifying their income structure, but we are still nowhere near the diversification level of leading global banks, which earn 40% to 50% of their revenues overseas,” says Shin Sang-hoon, president and CEO of Shinhan Bank, which earns 5% abroad.

Mr Shin wants to boost foreign income to an unspecified high percentage through acquisitions and equity investments in local banks in south-east Asia, central Asia and Russia. Concurrently, the plan is for the bank to increase its overseas networks to 30 from 16, and increase the countries it is represented in from nine to 17, within the next five years. It is currently negotiating with Japan’s Mizuho CB on setting up a “comprehensive co-operative relationship”, said Mr Shin, in an interview at September’s IMF/World Bank meetings in Singapore.

Growing profits

According to The Banker’s Top 1000 world banks listing (published in July), Shinhan’s pre-tax profits grew 51% to $1.9bn in 2005 and it is the third most profitable financial group in the country, with 32% profits on average capital.

Shinhan Financial Group’s acquisition of LG Cards – whose sale elicited interest from many financial groups – sent its assets up to Won219,000bn ($219bn), said the bank. And the largest bank in South Korea, Kookmin Bank, will see its assets increase to Won286,000bn following its acquisition of Korea Exchange Bank (KEB) from US private equity group Lone Star. The next largest financial group, Woori, has been left behind with Won187,000bn in assets.

Further consolidation among banks, and between banks and non-banks, such as insurers and brokerages, is forecast. This is driven by competition so intense that a report by rating agency Moody’s blames it for the difficulties in banks’ adoption of risk-based pricing – agency-speak for banks launching pricing wars while underestimating what percentage of loans might turn bad. Disappointed bidders for LG Card, such as Hana Financial Group, will also be looking for other assets to buy.

Raising the stakes

Competition is set to intensify as a free trade agreement is negotiated with the US, while the acquisition of local banks KorAm Bank by US-headquartered Citigroup and Korea First by UK-headquartered Standard Chartered is raising the stakes in terms of services. There are also moves to liberalise the non-banking financial services industry through the Capital Markets Consolidation Act. State-owned Woori Bank and Industrial Bank of Korea have yet to be privatised and could provide more consolidation opportunities.

Mergers and acquisitions are unlikely to include foreign banks, however, due to a perceived anti-foreign bias sparked in part by Lone Star’s sale of KEB to Kookmin. Completion of the sale has been delayed by an investigation into certain legal aspects of Lone Star’s acquisition of the then-troubled bank from the government in 2003. Foreign commentators allege that the nationalist furore over Lone Star’s tax-free profit of $3.8bn on the sale has resulted in politicians catering to populist anti-foreign feelings.

Even as the ruling party has been considering introducing measures to safeguard local companies from hostile takeovers, finance minister Kwon O-Kyu said in September that these “are fully allowed and the defence of such takeovers is the responsibility of the current management and the major shareholders of the company in question”, bringing to light the divisions in the government.

This reassurance for foreign investors came after a local outcry over US corporate raider Carl Icahn’s warning that he would launch a bid for tobacco giant KT&G unless it delivered better returns. Mr Kwon insisted that worries about Korean opposition to foreign capital had been “blown out of all proportion”.

Long-term interest

In a report, rating agency Standard & Poor’s (S&P) said: “Foreign capital was welcomed in the late 1990s, when the Asian financial crisis wrecked the domestic banking sector. But in recent years the government has clarified that it prefers involvement from foreign investors who have a long-term interest in the Korean market. Newbridge Capital, the Carlyle Group and Lone Star Funds are notable examples of overseas investment companies that have made a quick and sizeable profit turning around and selling off Korean companies.”

Not spooked

North Korea’s underground explosion in October, which it claims was a nuclear test, has not spooked the local or foreign banks with operations there, despite dominating international headlines. Rather, the banks recognise the long-term economic opportunities (see Bracken, The Banker, October 2006).

“We certainly have been offered opportunities [in North Korea] but I have held back. We are watching carefully to see how it evolves but the system is not ready for commercial activities to take place,” said Mr Shin. (This interview took place in mid-September, but Mr Shin confirmed he stands by his comments even after the October explosion.)

The South Korean economy is expected to grow at 4.8% this year and 4% in 2007, as the economy slows, according to Goldman Sachs. In the second quarter 2006, it grew at the slowest pace in a year, on the back of slackening consumer spending and a decline in construction as interest rates rose to 4.5%. The central bank has held rates steady over the past two months as oil prices have fallen. Political uncertainty over the Korean presidential election in 2007 is expected to slow consumer growth.

Mr Shin, meanwhile, is busy with LG Cards, which was restructured by its creditors after the 2003 Korean credit card crisis. He says the model for integrating the company is Chohung Bank, which Shinhan took over in 2003 and finished integrating in April this year. That lengthy process may be necessary in a country with disruptive labour unions, although currently the bank refuses to be drawn on whether there will be redundancies, saying it is too early to say. In any case, analysts are not expecting a large number of lay-offs because LG Cards has already been tightened up.

Separate entity

The integration will involve computer systems, for instance, but the credit card company will be kept as a separate legal entity from Shinhan Card for two years, although co-branding possibilities will be explored.

The acquisition makes Shinhan the dominant credit card player in the country. It gives the bank access to almost a third of the Korean workforce, says Mr Shin, with 16 million cards – its existing Shinhan Card operation has six million, while LG has 10 million. He is seeking to leverage the cross-selling opportunities and has hired a slew of derivatives experts to devise products for consumers. Cross-selling through branches in the country is unsuccessful due to the popularity of internet banking.

Some analysts say that LG’s 10 million figure is overstated because many of the accounts are dormant. Mr Shin says: “We do plan to approach the problem of non-active accounts with a long-term perspective. We would take a deep and concentrated look at the customer database and, utilising our group’s proven risk management capabilities, we would seek new opportunities among those clients in consumer finance and other customer enticement [areas].”

Credit cards are so widely used in South Korea that they can serve as identity cards in hospitals, and coffee shop customers might even pay for a $2 cup of coffee by card. Shinhan’s strong position in the card market might, therefore, also provide it with a platform to expand abroad.

The high-margin credit card business will boost Shinhan’s return on assets – currently 1.25%, according to The Banker’s Top 1000 data. Analysts say LG Cards is expected to generate average annual profits of Won1000bn over the next three years.

Recovery from crisis

Shinhan’s main competitor, Kookmin, posted a soaring 77% increase in first-half profits to Won1500bn on the back of rising interest income and falling loan-loss provisions, a performance that it is not expected to repeat in the second half as the economy slows. Like other Korean banks with credit card divisions, it is recovering from the 2003 credit card crisis. In 2004, it also suffered from bad loans in the small and medium-sized enterprise (SME) sector, where it has a strong position. The bank has 18% of total deposits and loans in the system.

Its takeover of KEB – widely expected to be finalised by the end of the year – will lessen its dependence on the consumer and SME sectors and allow its expansion into foreign exchange and corporate banking.

Kookmin is also seeking to expand abroad, helped by its acquisition of KEB, which has 28 overseas branches and controls 25% of South Korea’s export and import financing. It has pinpointed opportunities in Indonesia, Vietnam and India.

The Korean banking market is an exciting place for investment banks as the consolidation continues. With the government backing further mergers – “nothing happens in Korea without the government’s say-so” according to one foreign banker – S&P notes that Korean banks, insurers and brokerages are linking up in search of economies of scale and scope.

Both Shinhan and Kookmin are therefore set to spend the next years integrating their acquisitions, but will also be considering domestic acquisitions in the securities field and moving abroad.

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