No pause for Woori

Richard Jackson is the perfect banker to ask about the changes now afoot in South Korea's financial sector. When he first visited Seoul just over a decade ago as the 35-year-old head of Asia-Pacific insurance banking for Citigroup, South Korean institutions were little more than captives. The government was committed to directing finance toward the nation's famed chaebol , the multitentacled conglomerates at the center of South Korean development strategy since the late 1970s , and the banks took orders either from the mandarinate bureaucracy or the chaebol themselves. For foreign bankers like Jackson, the nation was a closed world , every bit the Hermit Kingdom of Korean tradition. "Back then it was as if the rest of the world didn't exist," says Jackson, who is again in Seoul, this time as Citibank's country business manager for South Korea. "I can't believe the changes since 1991 and 1992."

They are startling, all right. Earlier this year the government announced an ambitious plan to begin selling its large stakes in the banking sector, most of which are currently held by Woori Finance Holdings Co., an arm of the state-owned Korea Deposit Insurance Corp. set up last year to bail out 19 institutions that nearly failed following the 1997,1998 financial crisis. And although privatization is the centerpiece of South Korea's banking reform, it comes amid numerous changes banks have made on their own. Nonperforming loans have declined from a peak of more than $60 billion at the end of 1998 to an easily manageable $10 billion today. A shift away from the bigger-is-better era of chaebol lending to retail banking, mortgage lending and consumer finance has been more swift than anyone could have imagined even a few years ago. All this has been accompanied by a gradual loosening of regulatory controls, which has helped banks gain greater independence from government direction. "Regulations have moved on," Jackson says. "The whole environment has moved on from 'Here is what you can do' to 'Here is what you can't do.'"

Nothing epitomizes the new South Korean environment better than the deal struck by Lehman Brothers in early May. The New York investment bank is to spend up to $250 million buying convertible bonds that will give it approximately 5 percent of Woori Finance Holdings. (Woori means "our" or "we" in Korean, conveying the sense of "Our Nation's Bank.") As part of the deal, Lehman will own 50 percent of Woori Asset Management Co., a joint venture launched to manage more than $8 billion in NPLs on Woori's books, and may ultimately invest more than $1 billion if it goes ahead with a series of NPL purchases from Woori subsidiaries. Lehman's commitment could become one of the largest foreign investments ever made in the South Korean financial sector , and a striking vote of confidence when viewed against the spate of retreats from East Asian markets that other U.S. institutions have recently announced.

"We are very bullish about Korea. We have refocused toward North Asia," says David Kim, a Korean-American who arrived three years ago to run Lehman's financial institutions group in Seoul. "Korea represents tremendous potential , in advisory work, restructuring and market transactions. Korea has it all."

But the two-part Lehman deal also underscores the caution at the core of South Korea's reform plans. Gradualism is the running theme in Seoul. Lehman is not barging into the country the way Merrill Lynch did in Japan a few years ago , firmly believing that it would revolutionize the local financial sector. Lehman, by contrast, knows it is buying into a mixed system that is changing in stages. The law that created the Woori holding company last year gives the government three years to complete its privatization plan , a key incentive for KDIC and bank managers to accelerate restructuring efforts and list holdings publicly. Even so, there's no guarantee against delays, and the government will still own at least 40 percent of Woori's assets when the plan is completed.

Indeed, Seoul's blueprint represents the same mix of impulses evident throughout a society undergoing a rapid transition. Lehman or no Lehman, the extent of banks' independence from official intervention has yet to be established. At Woori Bank , Hanvit Bank until a name change in May and the centerpiece of the Woori group , influential executives are uncomfortable within the holding-company structure imposed on them and worry about losing their authority. Antiforeign sentiment, long a staple of Korean society, is still evident , as is political opposition fueled by unions protective of bank employees as institutions pass into the private sector. No one has forgotten that local investors successfully fought American International Group's plan to take over two troubled Hyundai Group financial units or that a militant labor union staged riots early last year against General Motors Corp. as the U.S. carmaker discussed the purchase of failing Daewoo Motor Co. In that case, workers briefly took over a Daewoo facility in Inchon and hurled Molotov cocktails at police.

All that said, there is no mistaking the basic commitment to change , among bankers as well as bureaucrats. "Korea and Malaysia are the only two Asian countries that have done serious restructuring work," says Dong Tao, senior economist in the Hong Kong office of Credit Suisse First Boston. "In Korea the NPLs have been pushed down quite a bit by the banks themselves."

To Jie Sung Han, special assistant to Woori group chairman Yoon Byung Chul, there is something inevitable about the direction Seoul has set for itself. "We really have no choice," he says. "How can you explain the government owning such a significant portion of the banking sector other than to say it was the result of the crisis situation Korea experienced in the past?"

The short answer to Jie's question is "You can't." Before the Asian financial crisis broke open in Bangkok in mid-1997, Seoul had been liberalizing its financial sector and gradually getting out of the banking business. But by the end of 1997, with the nation on the brink of bankruptcy and the won down by half against the dollar, Seoul abruptly took over the two worst-performing banks , Korea First Bank and SeoulBank. The International Monetary Fund, then negotiating a $58 billion bailout package, was not pleased. But the process went on. By the time it was done, the government controlled 41 percent of the country's commercial banking assets and said it had spent $120 billion (other estimates run as high as $150 billion) on its bank rescues.

Many of these institutions ended up within the Woori group, where the dominant banking unit continues to grow. Last December Woori absorbed the medium-size Peace Bank, which KDIC had taken over in 2000, and it is expected to fold in Kyongnam Bank and Kwangju Bank, two provincial institutions, by year-end. There is even speculation that, in the long run, either Woori Bank or the holding company could assume ownership of SeoulBank, South Korea's ninth-largest banking institution, with $20 billion in assets. Not including these potential acquisitions, estimates of Woori Bank's assets run to some $80 billion, second only to Kookmin Bank and its nearly $170 billion in assets. And it's a healthy set of properties. "We don't have bad banks," says Sohn Won Gihl, one of Woori Holding's managing directors, insisting, "Woori Asset Management [the Lehman partnership] is contracted to handle all the NPLs."

Seoul's postcrisis moves out of the banking business did not begin smoothly. Under the terms of its agreement with the IMF, the government had to sell both Korea First and SeoulBank. The latter is still on the block, but KFB made history in 1999, when KDIC sold 51 percent of it to Newbridge Capital, a U.S.-based private equity investment fund, making it modern Korea's first foreign-controlled bank. Under American Wilfrid Horie, who retired last year as KFB's president and chief executive, the bank shifted its emphasis dramatically.

"We did a major strategic initiative, called Pro-Branch, by which we rationalized the whole network," says Weijian Shan, the Newbridge managing director who negotiated the deal and now oversees the bank from his Hong Kong headquarters. "We opened and closed branches and renovated the layouts to make it friendly. We tried to strike a balance between corporate and retail. Now it's about 50-50. It used to be about 95-5."

Citibank's Jackson says KFB's strategic shift tracked currents in the South Korean marketplace: "It's no different from other banks that have gone through the same development curve. Personal lending to households of late has exceeded lending to corporates. Our own consumer area is growing quickly."

South Korea needs this kind of shift in its economic emphasis if it is to supplement its historic reliance on export revenues from the chaebol. The results of KFB's consumer banking drive have been salutary. The bank's return to profitability, with net income of $156 million for the first six months of 2001, was handsomely ahead of schedule. And it's remained profitable since.

But the pace of change has proved a problem, and the KFB deal has not gone down easily. Pursuing a flat, Western-style management structure, the bank let go several hundred employees , mainly via early retirement , from its staff of 5,000. Although relatively mild by U.S. standards, the cutbacks were hardly popular.

More important, KFB balked at extending fresh loans to Hynix Semiconductor, a hobbled chip maker. Last autumn the bank opted to collect 28 percent of its $175 million in outstanding loans rather than accept more exposure. It was a tiny fraction of the company's $6.8 billion in liabilities, and KFB wasn't the only bank to start moving against Hynix. But the symbolism was unmistakable: This was a foreign-controlled bank willing to let heavy-industry clients twist in the wind, even if it meant reduced earnings. (Hynix has continued to stumble. Its board rejected an offer from the U.S.'s Micron Technology at the end of April to buy Hynix plants, sending the company's remaining lenders scrambling to devise a strategy for Hynix, which most analysts agree can't survive on its own.)

Newbridge's greatest offense at KFB, in the eyes of the local banking community, was the terms of the takeover. It won agreement from the government that any hidden debts in the bank discovered after the purchase would be covered , an arrangement that has so far cost Seoul several billion dollars. Now, a source at KDIC says, "We will hold on to our 49 percent of KFB until we find someone more responsible than Newbridge" , which, he adds, is viewed among South Korean bankers as "more or less a vulture-type" fund. Newbridge's Shan is hardly apologetic: "All our bad loans are either provisioned or protected by the government" by prior agreement. In general, he adds, "Korean banks have started to become much more disciplined since the crisis," and "bad creditors would find it much more difficult to get loans."

By working in equal partnership with a local bank (rather than buying one outright as Newbridge did), Lehman is pursuing a less controversial course. Sohn at Woori says the Lehman deal reflects some of the hard lessons of the Newbridge negotiations. To date, the plan, which spreads control and doesn't require a government backstop, is proceeding pretty much as hoped. Apart from its half interest in Woori Asset Management, Lehman took Woori through a pivotal stage in May and June, when the investment bank sold 12 percent, or $500 million, of Woori Holdings to a variety of institutional and retail investors and later offered the shares for trading on the Korea Stock Exchange. Noting that the issue was many times oversubscribed, Min Euoo Sung, vice chairman and CFO of Woori Holdings, says simply, "We completed the IPO successfully."

The IPO also set an important precedent for future transactions. "It was the first case," says Min, in which a bank kept alive by public funds "was refunded by the market mechanism" rather than sold to an outside investor. Woori's successful "domestic IPO was the first step of testing this strategy on the market," adds Min, who ran Salomon Smith Barney's operations in Seoul prior to joining Woori last year.

Kim Jong Tae, leader of resolution planning at KDIC and the man directly responsible for putting the privatization plan into practice, wants to keep the momentum going. Shortly after the share offer, Woori announced a plan to raise an additional $750 million to $1 billion next June via a New York Stock Exchange listing. Kim figures the public markets can't absorb more than about $3 billion. As a result, KDIC and Woori are also interested in pursuing a block sale to domestic and international institutional investors. The goal, says Min, on the eve of a U.S. road show in late June, is to attract five to ten major global firms, supplemented by another 20 to 30 smaller participants from inside and outside South Korea, to take a substantial Woori stake from KDIC. Sohn explains that neither Woori Finance Holdings nor KDIC wants to get into piecemeal sell-offs of the company's assets. "We're looking for a joint venture for all sectors," Sohn says. "The subsidiaries will not be sold off one by one."

KDIC has had less success to date in unloading Cho Hung Bank, which, like SeoulBank and KFB, was never folded into the Woori portfolio. A 105-year-old financial institution that is by far South Korea's eldest and still commands considerable loyalty among older Koreans, Cho Hung, the nation's fourth-largest bank, got into trouble through its excessive exposure to the Ssangyong Group, a second-tier chaebol. It also remains heavily exposed to Hynix, among other large companies. Because of Cho Hung's venerable reputation and size, this sale is viewed as an important barometer of the privatization scheme's progress. However, KDIC in June postponed a global depositary receipts offering for 10 to 15 percent of Cho Hung's assets because overseas investors didn't want additional exposure to the strong local currency. For the moment at least, the sale will have to wait.

Currency concerns notwithstanding, now is the time to push new securities sales. South Korea's economy is booming: Gross domestic product is expected to expand by at least 6 percent this year. The stock market is up 64.5 percent from its low last September, and banking stocks are up 91.5 percent. In addition, the banks have done an admirable job of reshaping themselves. All but one of the nation's 21 banking institutions posted profits last year. Lending problems have subsided so far that the Korea Asset Management Corp., a government entity that was mandated during the 1997 financial crisis to buy and dispose of NPLs, has said it will no longer use government funds to acquire them after the end of this year, a sign of how sophisticated local banks have become in managing their own affairs.

They certainly have to be adept to keep pace with the rapid changes in their basic business. Individual consumers, to put the point simply, are now king in South Korea. Consumer credit extended by all financial institutions totaled W342 trillion last year , nearly $280 billion , a 28 percent increase over 2000 and nearly double what it was in 1998. In part this is explained by the rise of Internet banking, which is notably advanced in Korea, and the increased use of credit cards. Indeed, individuals now absorb more than half of the credit extended by South Korean banks. At the time of the crisis, the chaebol accounted for more than 80 percent of all credit.

What's at issue is a fundamental shift in attitude toward both individual consumers and the chaebol, whose economic preeminence was once a given. Long term this has significant implications for the weaning of South Korea away from export dependence in favor of an economy more reliant upon domestic demand. "Only a few years ago, the individual consumer was a cheap source of funds," says Citibank's Jackson. "Since the economic crisis of 1997 and 1998, consumers have come into their own as respected customers." Even the IMF is delighted with this shift. "Consumer lending has been one of the big changes," says Charles Adams, assistant director at the Fund's Asia-Pacific office in Tokyo, "and we think it's quite significant."

But Adams raises an uncomfortable conundrum in the same conversation. How fundamental is the change in South Korean banking , how deep and lasting will it prove to be? Adams's less than conclusive answer: "It's hard to tell."

Among the biggest concerns is the true extent of banking independence. Yes, there are plenty of signs that this autonomy holds sway , notably, KFB's stance toward the chaebol. More recently, Seoul has made it clear that Hynix cannot count on another bailout. Government officials are adamant on this point. "The banks are now very independent compared with what they were before the crisis," says Joo Hyung Hwan, director of the banking system division at the Ministry of Finance and Economy. "There's no government pressure at all."

Not everyone is convinced. To draw from the KFB example once again, consider that KDIC avowed caution in shopping its remaining 49 percent share of Korea First. "The government has changed its policies quite a bit, but it still may assert influence," says CSFB's Tao. The expansion of consumer credit, he points out, gives individuals a place at the table they've never before had , and greater influence, perhaps, in opposing government intervention. But it's a gray area and likely to remain one. "Nobody can rule out intervention," Tao says.

Consider, too, the government's remaining stakes in the banking sector: In addition to its holdings in Woori, these include three state banks , Korea Development Bank, Industrial Bank of Korea and Export-Import Bank of Korea , whose privatization is not even in the discussion phase. Via Ex-Im Bank and Bank of Korea, the central bank, it has also kept control of Korea Exchange Bank, even though it sold a third of KEB to Germany's Commerzbank during the crisis. All told, the government now owns majority stakes in 29 percent of South Korea's commercial banks. By comparison, major foreign firms own 18 percent, and diversified private domestic and overseas investors hold the remainder.

Another concern is the continued exposure of banks to overleveraged companies. "The chaebol have been clearing up their debts, but the other question is whether the middle group of companies are restructuring," says an IMF analyst in Seoul. "Something like one quarter of Korean firms don't make enough operating profit to cover their interest payments." The banks "could be capitalizing their interest," he observes , that is, rolling over the payments and adding to corporate debt. "Creditor banks need incentive to take action," the analyst adds. "If a firm can't cover its interest costs, it should have the incentive to restructure or liquidate."

There is also the explosion of consumer credit, which many view as both a blessing and a potential danger. Although the shift to domestic retail services is welcome, the pace is worrisome: Some officials and bankers question whether they are not watching the growth of a bubble that bad economic news or a loss of confidence could one day burst. Most banks are extending at least twice as much credit as they did a year ago, partly through the proliferation of credit cards, and Bank of Korea recently increased the basic interest rate by 25 basis points, to 4.25 percent , a modest uptick taken in the banking community as a note of caution.

In the end, though, concerns over the credit explosion may reflect the newness of the phenomenon in a nation of assiduous savers more than any real peril. Credit in South Korea is equivalent to 90 percent of disposable income, points out Na Sun Hwan, general manager of the consumer loan department at Woori Bank, compared with 107 percent in the U.S. and 113 percent in Japan. "Consumer spending is still relatively low compared with other advanced countries," Na concludes.

Can anyone say that South Korea's banks and bureaucrats will not revert to their old habits? Not definitively. The National Assembly has passed a bill, endorsed by both major political parties, that would permit a chaebol to own as much as 10 percent of a bank, rather than the 4 percent that has long been the cap. President Kim Dae Jung is expected to issue a decree this month declaring the bill's enactment. To be fair, the chaebol may be the only domestic entities large enough to make the kind of investments KDIC is looking for, and the bill stipulates that a chaebol's stake would have to be held by a separate finance subsidiary. Nonetheless, many see the proposed legislation as a worrisome sign of potential backsliding.

But for all the risks and uncertainties, the mood at KDIC is upbeat these days. "We've established a continuing restructuring program," says a senior economist there. At the banks, she adds, "We have profit-oriented management and independence from political interference." The privatization project in South Korean banking is likely to be gradual and long, certainly, and the result will be Korean in character , a model influenced by others but a copy of none. But in the KDIC economist's view, "Privatization is the most important project we have to concentrate on." And there is every sign that enough Koreans recognize this to make the goal a reality.