Bank consolidation, Korea-style: Asiamoney, February 2001

Asiamoney cover story, February 2001

 Korea’s government has announced the “second stage” of its financial restructuring programme, starting with the creation of two “super-banks”. The merger of Kookmin and H&CB, apparently through the choice of its own CEOs, makes sense. But the creation of a holding company including Hanvit and a group of regional banks seems, at best, eccentric. But what seems practical elsewhere in the world doesn’t necessarily work in Korea. By Chris Wright.

 You know you’ve made an unpopular decision as a manager when your own staff barricade you into your office for two nights, vetting your mail and occasionally threatening to set themselves on fire. Such was the reception Kookmin Bank chairman Kim Sang-hoon got when he announced his intention to merge his bank with fellow Korean retail leader H&CB.

The incident was resolved quickly enough, and in any event was hardly unusual by local standards. (“Oh, that was mild!” remarks one western banker who has lived in Seoul for eight years. “They didn’t beat him up. There wasn’t even any tear gas used!”) And the merger, by most measurements a sensible one, will almost certainly go ahead. But as a harbinger of the difficulties involved in the restructuring of Korea’s banking sector, it could hardly have been clearer.

Korea faces a still unstable corporate sector that has already unleashed a series of damaging and unprecedented failures, leading in turn to the collapse or near-bankruptcy of several of its leading banks. And it has to resolve these problems while being confronted by some of the most militant labour unions in the world. But the government steadfastly believes banking consolidation will help it out of this mess, and it isn’t going to be deterred by unpopularity. In December, as the showpiece of what it calls the “second stage” of financial restructuring, the government announced its blueprint for the future of its banking sector: the creation of two “super-banks”.

Kookmin/H&CB will be one of these superbanks and – despite Kim’s unhappy incarceration – is much the less baffling of the two mergers. The second involves an association of four near-bankrupt banks having their shares cancelled, being pumped with public cash from the Korea Deposit Insurance Corporation (KDIC) and being stuffed into a government-owned holding company, in which they may shortly be joined by another ailing institution, Seoul Bank. This one requires thoughtful analysis. But the handling and progress of these two mergers will be absolutely key to the future of Korean banking and the success, now and in the future, of the reform of the country’s financial system. This is a great opportunity and a potential disaster; a time to hold one’s breath.

 Kookmin and H&CB

The merger of Kookmin and H&CB is the sort of transaction we have become familiar with in global banking, and most people believe it makes sense. Both banks are leaders in the retail market, and partly as a consequence of that specialization, are among the healthiest in the country. That’s because they did not have corporate exposure to anything like the same degree as other banks, such as Hanvit, when the economic crisis hit Korea in late 1997. In fact non-performing loans after the merger will be around 6%.

The merger has caused some to comment that it pushes together two similar institutions when it would be more useful to combine institutions with different skills in the style that has become common in international mergers: Citibank, the commercial bank, merging with Salomon, the investment bank, for example. But although there are overlaps between Kookmin and H&CB, particularly in their branch network, the two do have different strengths. H&CB is a leader in mortgages, Kookmin in consumer banking and credit cards. (Kookmin Credit Card is actually a separate stock to Kookmin Bank.) The new bank will also have strength in corporate lending towards small and medium enterprises, FX dealing and swaps, and derivatives.

“Neither Kookmin nor H&CB has a fully-fledged retail franchise,” says H&CB’s chairman, president and CEO, Jung Tae Kim. “One to one, there is a lot of synergy between the two banks. This is not simply an upsizing of the retail banking side.”

Analysts tend to be positive. “If the potential merger between Kookmin and H&CB materializes they will have about a 28% market share of deposits,” says Sunmok Ha, an analyst at Credit Suisse First Boston in Seoul – and a former bank restructuring head at the Financial Supervisory Commission (FSC). “We expect the combined bank to have unrivalled pricing power.” CSFB has an overweight rating on the stocks in light of the merger, Deutsche is positive about it, and so is Samsung Securities, for example. CSFB predicts total incremental net profit will reach W325 billion (US$260 million) by 2003, with net profit figures over the next three years of W1.2 trillion, W1.9 trillion and W2.4 trillion. It expects a combined market cap of W24.5 trillion by 2003, which would make it one of the three largest stocks on the Kospi.

It is slightly more problematic to establish how the merger came together in the first place. Four senior, well-placed sources told Asiamoney that: 1) it was all Kookmin’s idea, starting with the CEO; 2) it was all H&CB’s idea, starting with the CEO; 3) it was more or less a mutual decision between the banks, and the government pushed for it to be accelerated as a useful source of momentum for its next phase of banking restructuring; and 4) it was the government’s idea from the outset, and a senior FSC official phoned both CEOs during the Kookmin incident to demand that they proceed with the merger. Clearly, they’re not all correct.

The probable truth is that this merger came together through both CEOs, and that the government – having pushed the country’s banks to consider mergers for so long – was so pleased with this development that it became deeply involved in the merger’s publicity, trumpeting it as part of a government restructuring plan and probably urging the two banks to announce the merger at a time that suited it. But the government should be wary of trying to credit itself with any part in the merger, because from an international standpoint, the transaction looks altogether more healthy if it appears that the government had nothing to do with it. International institutions such as the IMF have always held that although banking consolidation is a good thing, it must be done on a purely commercial basis – not just because a government or regulator thinks it should happen.

In fact, the government will be a major shareholder in the merged institution, holding around 10% of the company. But that’s not enough for real leverage and it seems unlikely that the government will attempt to shape the bank’s policies – besides which, shareholders with similar stakes include Goldman Sachs and ING Barings.

So if the merger makes sense, why the complaints from the union? Well, inevitably, the merger will involve some job cuts, and the fact is that Korea’s banking employees have already seen as much redundancy as they can tolerate. Many Korean banks cut as much as 35% of their staff through the financial crisis, and the mergers that have taken place – notably Hanil Bank and Commercial Bank of Korea to create Hanvit 18 months ago – have involved huge lay-offs and closures. This time Kookmin’s union heard the word merger, pictured vast redundancy, and the result was an extended stint in the office for Kim Sang-hoon.

But the reason they let him out again is partly because the scale of redundancy being talked about in this merger is not the same as in other Korean mergers to date. Both sides are at pains to explain that, this time, blood-letting will be minimal. Duk-Hyun Kim, executive vice president at Kookmin, believes this softer approach is good business sense. “We recognize the failure of other mergers… where they automatically reduced their branch network by more than 50%,” he says. “The result was terrible. They lost their customer base – almost 30-40% of customers went to other banks. We don’t want to follow such a case. There is no need to reduce significantly the number of branches or people at this time.” (It’s only fair to let Hanvit put its own point of view across here, since Hanvit’s creation from Hanil Bank and Commercial Bank of Korea is the sort of transaction Kim is referring to in that remark. Investor relations general manager, Kil Seok Suh, says: “Some people say the merger process was not well done, but I don’t agree. It was actually very successful when we consider the Korean culture. There had never been a bank merger before in Korea.”)

H&CB’s president, Jung Tae Kim, makes the same point as his namesake at Kookmin. “Look at the failed cases of Korean bank mergers in the past. Why did they fail? Because they tried to cut drastically the organization’s branch network and staff without taking into consideration a customer retention programme. A shrewd early retirement programme will size down the staff members as much as we need to, and even then we should do so gradually – we need to create value, not destroy value, and think about retention of our customers.”

Exact numbers are difficult to come by, but a likely figure is a 10% staff reduction this year and then 5% annually through 2002 through natural attrition, with the majority of that number being removed through early retirement. Instead the banks point to IT as a less sensitive area for significant cost savings. “Both banks spend about W200 billion on IT each year,” says Kim at Kookmin.

That should appease the unions – who, in fairness, have generally understood the need for reform in recent years. But is it the most sensible approach for the bank? CSFB’s report speaks of two scenarios, one titled “likely” – using the numbers above – and the other “optimistic”, calling for 10% reductions annually. Using this and other data, the difference to forecasted profit within three years is over W300 billion, according to the report – so clearly the analysts believe the bank would be better off laying off more staff. Both Kookmin and H&CB insist the activities of labour unions made no difference whatsoever to the merger, but these numbers do give pause for thought.

Then again, the banks may genuinely feel that provided they are able to generate strong profits, they have a social responsibility to look after as many of their staff as they can. Although that loyalty does not translate into the best figures, it is difficult to argue with. And many believe that the unions themselves are losing strength and public support – although it is interesting to wonder what would have happened if the strike had not happened in winter, when daytime temperatures in Seoul routinely drop below freezing, and before Christmas, when people have a more pressing need for cash than usual.

The merger should be completed in the first half of this year, and a memorandum of understanding was signed on December 22. The only aspect of the merger that might take time to resolve is that H&CB is listed on the New York Stock Exchange, which brings in to play the notoriously ponderous US SEC. In the meantime a six-man merger committee, with two people from each bank and two independents, is trying to decide who will be the CEO. Both are respected individuals but the most common prediction among observers Asiamoney spoke to was that Kim Jung Tae, H&CB’s president, would get the top job.

 The Hanvit “holding company”

When you look through the pages of this magazine, you will see Hanvit features prominently elsewhere – in Deals of the Year 2000. The JP Morgan-led subordinated bond deal for Hanvit in early 2000 is our bond of the year, a seminal and influential piece of financing that suggested the opening of a whole new market.

It was good for the capital markets, but it wasn’t enough for Hanvit. Shattered by its exposure to ailing Korean corporates, particularly Daewoo, the bank simply ran out of capital. It wasn’t alone – plenty of other national and regional banks found themselves in the same sorry position.

The government’s solution to this problem is certainly innovative, but also perplexing. In December it announced the creation of a holding company to contain Hanvit, Peace Bank of Korea, Kyongnam Bank, Kwangju Bank, Cheju Bank and Seoul Bank. (Subsequently Cheju Bank was taken out of the grouping and will instead be merged with Shinhan Bank; meanwhile Seoul Bank will only join the holding company if it is not sold – see below.) Each of the banks immediately became state-owned, and was ordered to write down the value of its shareholders’ capital. Then Korea Deposit Insurance Corporation injected around W7 trillion  into the banks.

The government is at pains to refer to this as a holding company, not a full merger, but given that its exit strategy is to privatize its holdings in the banking sector, it must be fair to assume that the institutions will eventually be merged. Anything else would be difficult to explain or sell to investors. This matter of semantics probably also has a lot to do with the spectre of union pressure – every bank in the holding company either had to withdraw from its banking union or make sure that the union would support the restructuring process, otherwise no funds would be released.

There are several questions about how this will work. David Coe, the IMF’s senior resident representative in Seoul, has these concerns. “Hanvit, which is itself a bank created out of the merger of two other banks, has an important job to do to improve its own management, to install new systems, and basically get its act together,” he says. “This is a big job and requires lots of management resources. We would not want to see that work fail or be postponed because of a forced merger requiring management to devote resources to it. Secondly, we don’t understand how one solves the problem of weak banks by lumping them all together.”

He says the IMF had been particularly concerned about the possibility of a forced merger of several large banks – there was talk of Hanvit being merged with Korea Exchange Bank, for example, a proposal which fell down when KEB’s major shareholder, Commerzbank, refused to allow it to be a part of a holding company. Coe says he is pleased that didn’t happen. But he adds: “We have no objection in principle to the creation of financial holding companies, and there is no reason for the government to try to prevent agglomeration – indeed, we can see reasons why the government should try to encourage it. But it should be on commercial terms. There is no reason for the government to be pushing it.”

The clearest statement of government intent on these pages comes in the interview with Kap Soo Oh, the assistant governor of the FSS (the arm of the FSC that implements its policy) – see page 56. But in essence, the government’s view is that after the difficult mergers that gave birth to Hanvit, the idea of integrating three small regional banks with the bigger institution should be a doddle – not that this is technically a merger (yet). And the reason for forcing banks to merge is because market forces take far too long to bring results, and Korea’s financial system needs to be reformed now. As Michael Hellbeck, a Seoul-based director in Deutsche Bank’s global banking division, says: “If you want to achieve something fast there is no alternative to this policy. If you want the market mechanism to conduct it you have to wait 10 years. And you can’t ask for market-driven reforms right now because the whole market is dysfunctional.”

On the issue of combining bad banks, KDIC’s executive director, Seung Hee Park, admits: “On the surface it may appear that four bad banks into one creates a super-bad bank. But closer analysis shows they are configured of banking operations which, if reconfigured to amalgamate these operations, may improve the competitiveness of the new holding company.”

The use of public funds itself has actually come in for very little criticism. “When you have the type of banking crisis Korea has, you really don’t have any choice,” says Coe. “Every country that is faced with this kind of crisis ends up putting public money in – including the USA and Sweden. A lot of the money has gone to stand behind the deposits of the Korean depositors. You have this image of money being poured down a black hole but it’s not like that at all. We don’t have any illusions that there was a painless way of doing this without using hard money.”

Hanvit spokesmen are limited in what they can say about the holding company, not because of any restrictions, but because they don’t really know how this is all going to work out. Kil Seok Suh, general manager in the investor relations department, suggests: “Making a holding company together with other banks makes sense when you think about the overbanking problem – there are so many banks compared with the size of the market. I’m not sure if there will be any synergy effects. It is too early to say. But we can save costs in computer systems, and by reducing our number of branches.”

By March, the management of this holding company should have been appointed – and the name at the top will tell us a lot about what happens next. Regulators say they want somebody with experience of banking, which isn’t as obvious a criterion as it sounds – many have complained that people with government backgrounds have too frequently been put into management positions in Korea. Certainly, a proven commercial banker at the head of the group would be a much better sign than a government figure, and one name does suggest itself right away: whichever CEO does not get the top job at the merged Kookmin/H&CB bank. We asked Park at KDIC about that. Predictably he declined to comment in detail, but did say this much: “It does not appear that the future CEO will be from KDIC. KDIC has its eyes open for somebody the market would recognize as being capable of leading. That means experience of the finance industry is mandatory.”

Analyst opinion on this merged entity is harder to find because basically there is no point in analysts covering it – it is no longer a stock that you can buy, at least for the moment, because the government owns the lot. But some are prepared to comment. “Hanvit Bank has been in trouble for a long time, three or four years, and I expect it will take a while for it to restore its power and market influence,” says Sunmok Ha at CSFB. “But with the additional government funds they can gradually improve their market share. I don’t think the small banks in the holding company will have a significant impact on Hanvit’s management because they have a very small presence.” He does not expect Hanvit to incur further significant losses from the bank’s loan book.

At Samsung Securities, senior analyst H Jin Lee says: “The holding company structure is somewhat modelled after the one in Japan, where the ultimate purpose would be a merger of those banks, and to that extent I think it is a move in the right direction. But if it is not, and is a way to bundle these banks together, then we will have some problems in terms of unfair competition for the private, quality banks.” But he adds: “The government in its policy statements until now has given strong indications that that is the ultimate goal of the holding company – to merge the banks together.”

Seoul Bank’s future is unclear. Reports in Seoul speak of a deadline of the middle of this year for the bank to be sold, otherwise Seoul Bank will be put in the holding company too. That would be a shame. David Coe at the IMF says: “Our view is that the management of SeoulBank is making a lot of progress. This very important work, to clean up the balance sheet and change management practices, takes time. But really the new management only started in July – so that’s not giving them much time. We don’t understand the rush to push Seoul Bank into the financial holding company if they have not been privatized.” Deutsche Bank has an advisory mandate to prepare the bank for sale, and is also mandated for the eventual equity offering: 24 Deutsche bankers presently reside within Seoul Bank. Michael Hellbeck at Deutsche also notes a tight deadline makes it harder to sell at a good price, but insists that morale within Seoul Bank is actually very high as organization continues apace. Interestingly, when we raised the issue with the FSS, they said there was no such deadline and that they would be prepared to give Seoul Bank time to turn itself around (see interview).

It would be good for all parties if Seoul Bank was sold in its present form, not just for the sake of Seoul Bank itself. It it does end up being pushed into the holding company with Hanvit, then there really are some integration issues to deal with. Hanvit absorbing three small regional banks is one thing; merging with another large institution is quite another.

Elsewhere, the future of KEB and Cho Hung Bank, which are both in the middle of government-imposed restructuring, is open to conjecture. Some still predict a merger between KEB and the Hanvit group. And the well-publicised merger negotiations between Hana Bank and Koram Bank are off again at the time of writing, but most observers believe the deal will still go ahead.

That being the case, it is possible to picture a landscape of less than 10 Korean banks within a few years. The real question is what they will look like. If the Hanvit group can deal with the combined challenges of a four-way merger, government ownership, projected sale and a loan book that is still exposed to the rigours of corporate Korea, then perhaps the government’s policy will be vindicated and we could see a domestic Korean powerhouse rise up. If not, and if all this does not come together, it will be a serious blow to the progress of financial restructuring in the country. The next six months will be key.