Banking: no end in sight to merge mania

South Korea’s banking industry, which went through a period of dramatic consolidation this year, is likely to see more mergers and acquisitions in coming years, as Korean lenders continue their efforts to inflate their size in the rapidly consolidating and scale-conscious market.

Analysts say there are still some M&A opportunities for international investors who want to gain a foothold in one of Asia’s biggest banking markets. Korea Exchange Bank could come to the market again, now that Lone Star, the US private equity fund, has terminated its contract to sell the country’s fifth-largest lender to Kookmin Bank.

Hana Financial Group, in which Singapore’s Temasek Holdings and Goldman Sachs own a combined 19 per cent stake, could become an M&A target itself after it missed out on KEB and LG Card this year. And state-run banks such as Woori Financial Group and Industrial Bank of Korea are also in the pipeline, as the government accelerates efforts to privatise them.

“We are not seeing the end of the consolidation boom. There will be more M&A stories,” says Sung Byung-soo, a banking analyst at Prudential Financial.

Lone Star is expected to resume efforts to sell out of KEB, once Korean prosecutors’ extensive investigations into the US company’s 2003 acquisition of KEB is concluded. Analysts say Kookmin and Hana may bid again for KEB or approach Woori to gain control of the country’s third-largest lender.

The government, which owns 78 per cent of Woori, is planning to offload a 28 per cent stake in the lender to institutional investors in block sales. It is also trying to sell a 15.7 per cent stake in IBK and reportedly approached Societe Generale of France. IBK is 66.7 per cent-owned by the government.

Along with more M&A moves between banks, analysts expect to see aggressive efforts by banks to acquire brokerages, insurers and asset managers as they try to expand into the non-banking sector ahead of the Capital Markets Consolidation Act, which will liberalise the sector. “We will see more vertical consolidation as banks are keen to take over financial product makers to increase fee income,” says Bryan Song, an analyst at Merrill Lynch.

Analysts say Korean lenders need to reduce their heavy reliance on interest income, as the lending market is nearing saturation. Korean lenders have fared well, despite growing competition from foreign rivals after Standard Chartered and Citigroup absorbed Korea First bank and KorAm Bank respectively.

Korean banks reported record combined profits of Won8,100bn in the first half of this year and Samsung Securities expects their earnings to increase 27 per cent this year, helped by huge investment gains from restructured companies such as LG Card and Hynix Semiconductor.

“We have seen structural changes in bank earnings: earnings stability is increasing although the pace of growth is slowing. Their risk management is completely different from the past and I am not worried about their asset quality any more,” says Jason Yu, an analyst at Samsung Securities.

Korean banks have become much stronger financially, having overcome the Asian financial crisis and the bursting of the credit bubble. Korean banks’ BIS capital adequacy ratio reached 13.08 per cent as of end-June and their non-performing loans ratio fell to below 1 per cent at the end of September, the lowest since 1999.

But margins are expected to come under pressure next year as asset growth is expected to slow amid a cooling economy, and one-off investment gains are reduced. Competition is intensifying in the traditional lending market as Korean consumers become more cautious about borrowing money amid a murky economic outlook. Also, big companies are tending to rely more on their huge cash reserves or direct financing for investment.

“The lending market is getting saturated so margins will come under more pressure. They need to accelerate efforts to develop more advanced financial products,” says Mr Sung at Prudential.

The narrowing business opportunities are driving local banks to seek new sources of revenue, increasing their interest in taking over secondary financial institutions. They are expected to pay more attention to diversifying their business to improve competitiveness as the government is planning to break down walls separating the businesses of brokerages, insurers and asset managers.

Analysts say new growth momentum could also come from expansion overseas. Kookmin plans to build up its overseas network, either through organic growth or acquisitions. to become a leading bank in Asia.

Shinhan Bank, which took over LG Card this year, is also actively seeking M&A opportunities in south-east Asia, while Hana is interested in entering China and other emerging markets in Asia. Such efforts to expand abroad are expected to intensify in coming years, as the banks hit a limit with organic growth at home.

Helped by such diversification efforts, Korean banks are forecast to report returns on earnings of 19.6 per cent this year and 17.9 per cent next year, compared with 22.1 per cent last year, according to Samsung Securities. And they are becoming more exposed to foreign investors, with foreign stock ownership of market leader Kookmin reaching 82 per cent.

However, investors are not yet convinced of the fundamental strengths of Korean banks, with their valuations still about 20-30 per cent cheaper than their Asian rivals.

Terence Lim, strategist at Goldman Sachs, says Korean banks, still obsessed with size, should focus more on profitability if they want to be re-rated. “Bigger is not always better. They should be free from their obsession with volume for their valuations to be improved.”