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(The following statement was released by the rating agency)
Dec 21 -
Summary analysis -- Korea Exchange Bank --------------------------- 21-Dec-2012
CREDIT RATING: A-/Stable/A-2 Country: Korea, Republic
Primary SIC: Commercial banks,
Mult. CUSIP6: 500632
Mult. CUSIP6: 5006F0
Mult. CUSIP6: 5006F1
Mult. CUSIP6: 5006F2
Mult. CUSIP6: 5006F3
Credit Rating History:
Local currency Foreign currency
10-Feb-2012 A-/A-2 A-/A-2
22-Feb-2007 BBB+/A-2 BBB+/A-2
The stable outlook on the long-term issuer credit rating (ICR) on Korea Exchange Bank (KEB) reflects our view that the overall credit profile of the bank and the parent group, Hana Financial Group (HFG), is likely to remain stable despite an increasingly challenging operating environment, characterized by potential pressure on the quality of household debt and ongoing pressure on the real estate and construction and shipbuilding and shipping sectors. We believe KEB will likely manage the potential rise in credit costs with current preprovisioning profit levels.
We may raise the rating on KEB if it becomes an integral part of HFG and maintains its strategic importance within HFG in the coming two years.
On the other hand, the rating on KEB may come under downward pressure if the bank's or the group's asset quality deteriorates beyond our assumptions, or if their capitalization deteriorates materially, especially resulting in a risk-adjusted capital (RAC) ratio below 5% at the group level.
Standard & Poor's Ratings Services bases its 'bbb' stand-alone credit profile (SACP) on KEB on the 'bbb+' anchor rating, the bank's "adequate" business position, "moderate" capital and earnings, "adequate" risk position, and "average" funding and "adequate" liquidity.
Our bank criteria uses the Banking Industry Country Risk Assessment (BICRA) economic risk and industry risk scores to determine a bank's anchor SACP, the starting point in assigning an ICR. The anchor SACP for a bank operating only in Korea is 'bbb+'. The BICRA score reflects our evaluation of economic risk. We view Korea as a resilient and diverse economy with relatively strong growth prospects and few economic imbalances. Nonetheless, we believe high leverage in the private sector could pressure asset quality in the banking system if a sharp interest hike occurs amid an inflationary environment. With regard to industry risk, we view the Korean banking industry as underpinned by strong domestic funding, counterbalanced by some reliance on foreign-currency wholesale funding. We also view Korean banks' risk appetite as moderate, and the banking regulations comparable to international standards, although we regard the track record as mixed.
We expect KEB's business position to remain at "adequate," as KEB will likely maintain its current level of profitability in the coming two years. KEB has increased its focus on loan growth, as evidenced by faster-than-peer loan growth so far this year, and this has pressured its net interest margin. However, we expect the bank to maintain adequate underwriting standards, limiting significant increase in credit costs, amid a broadly stable competitive landscape of the Korean banking system. The Korean government established KEB in 1967 as a bank specializing in foreign exchange and international trade finance. The bank has been the dominant player in these fields since its privatization in 1989, as shown by its about 50% share of the Korean foreign exchange market. Nonetheless, KEB is challenged to improve its relatively small overall market position compared to major domestic banks. KEB is the fifth-largest bank among a total seven national commercial banks in terms of asset size, accounting for about 4% of total deposits in the domestic banking sector. Compared with its major bank rivals, the bank has relatively few retail branches and a weaker brand image as a consumer bank. HFG acquired KEB in February 2012, and the new management team has set its strategic focus to increase its loans to large corporates, partly leveraging off of its existing relationships with corporates. While we view that such a strategy could result in potentially higher costs amid challenging economic conditions, KEB will likely maintain its current level of profitability and asset quality measures through adequate underwriting standards. We note that while KEB has a relatively high portion of corporate exposure, including real estate and construction, the bank has maintained adequate level of asset quality measures in the past several years. In addition, we expect to see some modest revenue synergy between Hana and KEB, but we believe cost synergy will likely take some time to materialize as HFG's agreement with KEB's labor union to run Hana and KEB as separate entities for five years, is likely to slow down organization restructuring and cost rationalization.
We view KEB's capital and earnings as "moderate." KEB's RAC ratio before diversification and concentration adjustments was moderate at Dec. 31, 2011, and we expect it remain in the 6%-7% range in the coming 18 months. We also regard HFG's capitalization as moderate after factoring in the KEB acquisition. We believe that earnings capacity, excluding one-off items such as significant gains from the sale of securities, is moderate and is unlikely to build up a significant buffer. KEB's quality of capital is also good, with limited hybrid issues.
Our risk position assessment for KEB is "adequate," primarily reflecting our view that the RAC ratio adequately captures loan exposure risks. Although KEB has relatively high corporate exposure, including to real estate and construction, the bank has maintained its asset quality measures fairly well. The bank's nonperforming loan (NPL) ratio stood at 1.25% compared to a domestic peer average of 1.56% at the end of September 2012. Credit losses remained stable in 2012 compared to a year ago with an adequate level of provisions, and we expect the bank to maintain its credit losses at a manageable level in the coming one to two years.
KEB's funding is "average" and liquidity position is "adequate," in our opinion. Its stable retail deposit base underpins its funding profile. KEB's customer deposits account for roughly 80% of total funding, which is in line with the major peer average. The bank also reported a loan-to-deposit ratio of about 110% at Sept. 30, 2012, which is slightly higher than the domestic commercial peer average of about 105%, but lower than the domestic bank peer average of 120%. KEB's foreign currency funding, which stood at roughly 30% of total funding by the first half of 2012 (compared with a domestic peer average of about 14%), could pose a potential risk in an unfavorable foreign-currency funding environment. One mitigating factor for foreign currency funding related risk is that about 65% of KEB's foreign currency funding is deposits, while its domestic peers' foreign currency funding is mainly from the wholesale market. We also view the bank's liquidity as adequate, backed by a sizeable amount of government bonds, cash, and interbank balances.
We view KEB as an important subsidiary of the enlarged HFG, and KEB could benefit from potential support from the higher-rated Hana. We view Hana as having "high" systemic importance in Korea. We believe KEB could receive support from HFG, as a subsidiary with high importance.
We view that KEB could receive a one-notch uplift of its ICR given the "moderately high" likelihood of government support, due to its "moderate" systemic importance in Korea and our assessment of the government as "highly supportive," but it is overshadowed by stronger support from HFG, which lifts KEB's ICR by two-notches from its SACP.
Related Criteria And Research
-- Banking Industry Country Risk Assessment: Korea, April 19, 2012
-- Korea Exchange Bank Ratings Raised And Removed From CreditWatch; Ratings On Hana Affirmed, Feb. 10, 2012
-- Ratings On Korea Exchange Bank Placed On CreditWatch Positive; Short-Term Rating Affirmed, Dec. 6, 2011
-- Banks: Rating Methodology And Assumptions, Nov. 9, 2011
-- Group Rating Methodology And Assumptions, Nov. 9, 2011
-- Banking Industry Country Risk Assessment Methodology And Assumptions, Nov. 9, 2011
-- Bank Hybrid Capital Methodology And Assumptions, Nov. 1, 2011
-- Ratings On Korea Exchange Bank Affirmed, Off CreditWatch On Increased Uncertainty Over Acquisition, June 23, 2011
-- Ratings On Hana And KEB Affirmed; Hana Off CreditWatch Negative; KEB Placed On CreditWatch Positive, March 28, 2011