Hana Insight (Hana Institute of Finance)_Issue#3

2

Table of Contents

Feature 01 How Do Korea's HNWIs Manage Their Wealth?Warren Park, Juneun Kang

Issues 11 How Much a Threat Is Korea's Household Debt?Wanjoong Kim, Warren Park

17 Korea's Real Estate Project Finance Market: Diagnosis and RemediesJeungrak Sohn

23 Big Changes Afoot for Korea's Financial IndustryJaeman Song, Warren Park

30 Korea's Long-Term Solar Prospects Shine BrightHyeyoung Ahn

MarketWatcher

35 Interest Rates: Rates to be kept on hold for an extended periodWanjoong Kim

37 Exchange Rate: As uncertainties dissipate, a gradual strengthening of the KRW is expectedYootag Jung

39 Equities: A weak start in 2Q should pave the way to a stronger finishYonghyun Cho, Hana Daetoo Securities

1

Feature

How Do Korea's HNWIs Manage Their Wealth?

As Korea's financial services firms have come to realize, providing wealth management (WM)

services to high net worth individuals (HNWIs) can be a good way of generating a steady

stream of high-margin income. And given that Korea's HNWI population and wealth levels

continue to grow at a steady pace, it is no surprise that interest in the market has been on

the rise. As competition heats up in the market, banks and other financial institutions will need

to provide WM services tailored to the unique needs of their clients. Customer surveys such as

the one conducted recently by Hana Bank and the Hana Institute of Finance can help such

firms in acquiring a better understanding of HNWIs' attitudes toward their wealth and investing.

Warren Park, Senior Researcher Juneun Kang, Associate Researcher

[Figure 1] Whom Survey Respondents Consider "Wealthy" by Level of Wealth

48%

65%

27%

12%

11%

14%

21%

12%

34%

16%12%

21%

4%2%

All Respondents Total Assets

\5bn or Above

Total Assets

Below \5bn

Below \3bn

\3-5bn

\5-7bn

\7-10bn

\10bn or Above

Source: Hana PB Survey 2011

Hana Bank's recent survey provides insights into the attitudes of Korea's

wealthy toward investing

In late 2011, Hana Bank and the Hana

Institute of Finance conducted a month-long

survey of Hana Bank's private-banking cli-

ents to determine their attitudes toward their

wealth as well as how they manage it. The

survey was part of a general trend of

Korean financial institutions trying to gain

deeper insight into Korea's HNWIs and using

it to provide improved service to their

wealth management clients. This article pro-

vides a summary of the survey's key find-

ings along with some implications.

2

Mar 2012 Hana Insight

[Figure 2] Total Assets of Survey Respondents by Level of Financial Assets

39.9

67.6

114.3

139.4

155.0

288.9

744.4

\2bn or below

\2-4bn

\4-6bn

\6-8bn

\8-10bn

\10-20bn

\20bn or above

Average: \93.6 billion

(38%)

(37%)

(13%)

(4%)

(1%)

(5%)(2%)

(Percent of respondents in parentheses)

(Unit: \bn)

Source: Hana PB Survey 2011

The Hana PB Survey targeted customers

in the Private Banking (PB) unit of Hana

Bank who have financial assets of ￦1.0 bil-

lion or more, and questioned them on a

range of topics, including their attitudes to-

ward investing, wealth management, retire-

ment, gifts and inheritances, spending and

lifestyle. Three hundred seventy-nine people

participated in the survey. Their responses

were broken down and analyzed in terms of

factors such as level of wealth, age, and

area of residence, and the results were pub-

lished in February in a report titled "Wealth

Management of Korea's Wealthy Class."

Despite the limited size of the sample, most

of the results appear to be roughly in line

with other surveys. Thus, they can provide

helpful insights into the general attitudes of

Korea's HNWIs toward their wealth and

investing.

Whom do Hana Bank's PB clients

consider to be wealthy?

How one defines "wealthy" varies from

person to person and tends to depend on

one's own level of wealth. In the United

States, the Federal Reserve defines a HNWI

as someone with an annual income of

$100,000 plus a net worth in the top 10%

of US households. The more general defi-

nition, however, includes anyone with finan-

cial assets of $1 million or more. In the

case of the Hana PB Survey, 48% of re-

spondents said that one should have over

￦10 billion in total assets to be considered

wealthy, whereas 21% said ￦5-7 billion, and

16% said ￦3-5 billion. In other words,

around 80% of respondents believe that one

should have total assets of ￦5 billion or

more to be considered part of Korea's weal-

thy class.

3

Feature

[Figure 3] Annual Incomes of Respondents [Figure 4] Sources of Income of Respondents

15%

47%

23%

7% 7%

Below\0.1bn

\0.1-0.3bn

\0.3-0.5bn

\0.5-1bn \1bn orAbove

RentalIncom e

29%

Em ploymentIncome

14%

BusinessIncome

38%FinancialIncome

19%

Source: Hana PB Survey 2011 Source: Hana PB Survey 2011

What kinds of people responded to

the Hana PB Survey?

When asked about their annual income,

14% said they earn ￦500 million or more,

47% said ￦100-300 million, 23% said

￦300-500 million, and 15% said less than

￦100 million. With respect to sources of in-

come, 38% said their main source of income

was their own business, 29% said rental in-

come, 19% said financial investments, and

14% said employment income. The results

also showed that many HNWIs are business

owners and very active in purchasing and

leasing out retail space or other forms of re-

al estate.

In terms of area of residence, 42% of re-

spondents said they live in one of the main

three districts of Kangnam (Kangnam-gu,

Seocho-gu and Songpa-gu). The results also

showed that the number of emerging-HNWIs

living in one of these three districts or

Yongsan-gu － the centrally located area

along northern bank of the Han River － has

been rising over the past decade, whereas

the number living in the traditionally wealthy

areas of Seongbuk-dong, Hannam-dong and

Pyongchang-dong has been in relative de-

cline; this is particularly true for those with

total assets of ￦5 billion or more, 48% of

whom reside in one of the main Kangnam

districts. Moreover, of those respondents liv-

ing in one the main three Kangnam districts,

the majority were over 60 years old, sug-

gesting a general aging trend in Korea's

wealthy class.

In terms of educational achievement, 94%

of respondents have a bachelor's degree,

whereas 24% have a master's or Ph.D. Their

most common occupations are company CEO

(14.8%), self-employed businessperson

(13.5%), and professional (12.1%), followed

4


[Figure 5] Korea's HNWI Population [Figure 6] Financial Assets of Korean HNWIs

14.8

7.08.2

9.88 .6

11.6

13.5

15.9

2005 2006 2007 2008 2009 2010 2011 2012(E)

(Unit: 10,000 persons)

445415

369

314328292

269

429

2005 2006 2007 2008 2009 2010 2011 2012(E)

(Unit: \tn)

Source: BOK, Statistics Korea Source: BOK, Statistics Korea

by retired persons, company executives, com-

pany employees and those who live off their

real estate assets. Housewives accounted for

the highest percentage (31.3%) of re-

spondents; this is most likely because house-

wives tend to be responsible for handling

household finances and are therefore most

likely to respond to this type of survey.

One notable survey finding was that re-

spondents' ratio of assets to annual income

was very different from those of the average

Korean household. The average total assets

of respondents was ￦9.4 billion, whereas

their average income was in the ￦100-300

million range. This is in stark contrast with

the average Korean household, whose ratio

of total assets to annual income (￦40.12

million) is only around 7.4. This sort of gap

is evident in Japan as well, where the same

ratio for HNWIs is over 50. In both coun-

tries, the gap can most likely be attributed

to the tendency for the wealthy to inherit a

large portion of their wealth.

How large is Korea's HNWI pop-

ulation?

According to a variety of sources, Korea's

HNWI population, defined as those with fi-

nancial assets of ￦1 billion or more, was

148,000 in 2011, and is expected to grow to

159,000 in 2012. It is estimated that they

held ￦429 trillion (around 19% of total

household financial assets in Korea) in 2011,

and it is expected that this will grow by

3.6% to ￦445 trillion in 2012, equivalent to

￦2.8 billion per person.

Of the HNWI population's ￦429 trillion

in financial assets, about ￦237 trillion (55%)

is held mainly in bank deposits and ￦139

trillion (32%) in securities, mostly equities.

And given that the economic slowdown of

2011 is expected to continue into 2012, it is

5

Feature

[Figure 7] Types of Financial Firms Utilized by

Respondents for WM Services

[Figure 8] Share of Wealth Management Market

by Type of Financial Firm

1%

2%

2%

11%

14%

28%

43%

Insurance

Broker+Insurance

Broker

Bank+Insurance

Bank+Broker

Bank/s

Bank+Broker+Insurance Insurance9%

Broker17%

Investm entAdvisor 3%

Bank 72%


likely that their preference for safe assets

will increase, which should lead to further

inflows into banks.

In general, the wealth of HNWIs is man-

aged by a variety of financial institutions, in-

cluding banks, securities firms and insurance

companies. Of those surveyed, 43% said they

receive PB or WM services from all three

types of financial services companies. 28%

said they only receive such services from a

bank, 14% said a bank and a securities firm,

and 11% said a bank and an insurance

company. In other words, most HNWIs pre-

fer to manage their money through banks,

presumably because of the relative safety

that they provide.

Respondents were also asked how many

of each type of financial firm they patronize.

In the case of banks, 27% said they patron-

ize one bank, 39% said two banks, and 24%

said three, showing a general tendency to di-

versify banking relationships. Of those who

are clients of securities firms, 78% said they

patronize only one firm, whereas 19% said

they patronize two. In the case of insurance

firms, 41% said they patronize only one,

whereas 31% said two. Thus, it can be seen

that HNWIs are more likely to diversify

their relationships with banks than with se-

curities or insurance firms.

In terms of assets, respondents said they

put 71% of their assets in banks, versus

17% in securities firms, 9% in insurance

companies, and 3% in investment advisors.

The fact that the survey's respondents keep

most of their financial assets in banks is fur-

ther evidence that Korea's wealthy are inter-

ested in relatively safe investments.

6


[Figure 9] Allocation of Assets Held by

Respondents by Wealth Level

[Figure 10] Where Respondents Intend to

Increase Their Allocations This Year

48% 54%41%

8%8%

9%

16%14%

18%

28% 24%33%

AllRespondents

Total Assets\5bn or

Above

Total AssetsBelow \5bn

Deposits

Inv. Funds

Equities

RealEstate

21%

14%

18%

47%

10%

19%

23%

48%

15%

17%

21%

47%

Inv. Funds

Equities

Real Estate

Deposits

All Respondents

Total Assets \5bnor AboveTotal Assets Below\5bn


What types of assets do HNWIs like?

Survey respondents said they have 48%

of their assets in real estate and 52% in fi-

nancial assets, including 28% in deposits,

16% in investment funds, and 8% in

equities. In other words, they tend to favor

real estate the most, followed by deposits. In

addition, the results showed that the higher a

respondent's total assets, the more she is

likely to invest in real estate. Those with to-

tal assets above ￦5 billion had 46% in fi-

nancial assets, whereas those with assets be-

low ￦5 billion had 59% in financial assets.

For those who invest in equities, there was a

tendency to prefer indirect investing to direct

investing. Overall, it appears that the crisis

in Europe and other global uncertainties have

made HNWIs more risk-averse and thus

more likely to veer towards safer

investments.

Indeed, when asked about which asset

class they would like to invest in over the

next year, 47% said they expect to increase

their allocation to bank deposits, 32% said

equities (either directly or through investment

funds), and 21% said real estate. Those with

total assets of ￦5 billion or more were

more likely than those with less than ￦5

billion to say they intend to increase their

real estate holdings; this seemingly confirms

the general perception that the wealthiest in-

dividuals are more likely to invest in real

estate than those who are more modestly

wealthy.

As for how respondents attained their

wealth, 46% said it was through ownership

of a business, 21% said it was from real es-

tate investments, 21% said gifts/inheritance,

and 9% said employment income. Of course,

it should be noted that some of those who

said they received their wealth from a busi-

7

Feature

[Figure 11] Investment Preferences of

Respondents by Wealth Level and Asset Type

[Figure 12] Portfolio Return Expectations of

Respondents for the Coming Year

14% 15% 13%

22% 20% 23%

15% 16% 13%

26% 26% 25%

9% 9% 8%

9% 8% 10%4% 3% 6%

All Total Assets\5bn or

Above

Total AssetsBe low \5bn

Derivatives

Annuity

Insurance

Deposits

Fixed-Incom eOverseasFundsDom esticFundsOverseasEquitiesDom esticEquities

14%

54%

23%

6%

3%

0-5%

5-10%

10-15%

15-20%

20% orAbove

Note: Reflects top 3 allocations of each respondent


ness received it as a gift or inheritance. In

fact, about 21% of respondents said they re-

ceived an ownership stake in a business as a

gift or inheritance, but then grew their assets

through management of the business. It

should also be noted that those with total as-

sets above ￦5 billion were more likely to

have built their wealth through real estate in-

vestments or gifts/inheritance than those with

less than ￦5 billion.

What are the investment preferen-ces of HNWIs?

Upon examination of respondents' portfo-

lio allocations, it is evident that Korean

HNWIs have become more risk averse since

2008. Between 2008 and 2011, for instance,

there was a clear decline in the proportion

of real estate assets and investment funds － most likely the result of falling asset prices.

In contrast, there was an increase in the pro-

portion of deposits. Whether or not this

change in allocations is simply the result of

changes in asset prices is unclear, but even

if that is the case, respondents have not ac-

tively readjusted their portfolios to pre-crisis

allocations.

Upon closer look at specific asset classes,

we can see that investor preferences are

highest for deposits, domestic investment

funds and domestic equities, but lowest for

overseas equities, overseas investment funds,

and derivative products. This shows that

Korea's wealthy have become more wary of

high-risk and overseas assets, especially in

light of ongoing uncertainties in global finan-

cial markets, and are more confident in the

relative strength of Korea's domestic market.

When asked about 2011 returns on their

investment portfolios, 51% said they ach-

ieved positive returns for the year; 46% said

8


[Figure 13] Real Estate Investment Preferences

of Respondents

[Figure 14] Areas Where Respondents Intend to

Invest in Real Estate

Officete l16%

Building/RetailSpace47.4%

Land13 .9%

Apartment(Investment)

10.7%

Apartment(Residence)

11.2%

Overseas Real Estate 1 .1%48.7%

21.0%

19.6%

6.1%

4.6%

Seoul(Kangnam)

Seoul(Kangbuk)

Seoul MetroArea

6Metropolitan

Cities

OtherRegions


they had returns of 10% or less, whereas

30% said they had losses of 10% or greater.

Considering such tepid returns, it should not

come as a surprise that they had generally

lowered their return expectations for 2012. In

fact, a slight majority of respondents said

they expect to achieve returns of 5-10% in

2012. Indeed, such caution appears to be in

line with their increased allocations to

low-yielding bank deposits, perhaps reflecting

their relatively conservative expectations in

light of continued risks out of Europe and

increased chances of a global economic

slowdown. It should be noted that these re-

sults are in contrast with those of the Hana

PB Survey conducted right after the collapse

of Lehman Brothers in 2008, in which the

vast majority of respondents expected

one-year returns of over 10%, with 60% ex-

pecting 10-15%, and 18% expecting 15-20%.

When asked what type of real estate they

owned, most respondents said that the largest

proportion of their investments was their pri-

mary residence; this was followed by in-

come-producing real estate. When asked what

types of real estate they intended to invest

in during the coming year, 63.5% said in-

come-producing real estate such as office

buildings, retail buildings or officetels, with

overwhelming preference for office buildings

or retail buildings, given they provide a bet-

ter opportunity for capital gains than

officetels.

Of survey respondents, 53.4% hold real

estate in the Kangnam area. Indeed, almost

half of those respondents who expressed

their intention to invest in real estate ex-

pressed a preference for the Kangnam area.

This shows that, despite general expectations

that a sluggish economy and strengthened

measures to counter household debt will

9

Feature

[Figure 15] Main Concerns of Respondents

Regarding Gifts/Inheritance

[Figure 16] To Whom Respondents Intend to

Transfer Their Wealth

57.0%

31.6%

4.1%

2.4%

8.1%

Concerns About Ability toManage Wealth

Concerned Children W illLose W ill to Work

Fear Children W ill IgnoreParents

Concern About Others'Opinions

Other

6.2%

4.3%

3.5%

1.9%

84.9%Give Equally to Each Child

G ive to Child Who TakesCare of Parents

G ive to Child Who IsKindest to Parents

G ive More to Sons

G ive Mainly to Eldest Child


have a slowing effect on the overall real es-

tate market, their belief in the resiliency of

the Kangnam housing market has not waned.

Attitudes towards gifts and in-

heritance

As 48.4% of survey respondents were 60

years or older, it should not be surprising

that they are interested in gifts/inheritance

issues. An overwhelming percentage, 93.1%,

said they plan on passing their assets to

their children, while 9.9% and 2.8% said

they would give their assets to their spouses

and grandchildren, respectively.

As for the types of assets they intend to

transfer, 57% said real estate, 37% said cash

or deposits, and 12.6% said securities. In

general, those over 60 are more likely to

transfer real estate assets. Meanwhile, in the

case of business owners, a large proportion

responded that they plan to transfer their

ownership and management rights, showing

that many wealthy business owners want to

keep their business in the family.

Of those who said they plan to transfer

their assets to their children, 57% expressed

concern about their children's ability to prop-

erly manage their gifts/inheritance, and this

concern was even stronger for the wealthiest

respondents. Another 31.6% of respondents

said they are worried that giving gifts/in-

heritance to their children could cause them

to lose their desire to work. Somewhat sur-

prisingly, 5.2% of respondents said they did

not plan to leave an inheritance to their fam-

ily members, but rather to donate their

wealth to charity or a social cause.

Conclusion

As can be seen from the results of the

survey, the typical Korean HNWI tends to

10


possess certain traits. First, they tend to rely

on banks more than other financial in-

stitutions to take care of their wealth man-

agement needs. Second, they tend to prefer

investing in real estate over financial assets.

In particular, they tend to prefer in-

come-producing real estate such as office

buildings or retail space over officetels － an

indication that they seek capital gains in ad-

dition to rental income. Third, Korea's weal-

thy have become more risk-averse since the

financial crisis, and this can be seen in their

allocations to various asset classes as well as

their preferences within a risky asset class

such as equities.

Korea's wealthy class will continue to

grow at a steady pace, and for those finan-

cial firms that are leaders in providing

wealth management services to such clients,

the rewards should be plentiful. Of course,

capturing this class of customers will not be

easy, but will require constant effort to un-

derstand the needs of wealthy individuals

while delivering tailored services in such a

way that can earn their trust and loyalty.

11

Issue

How Much a Threat Is Korea's Household Debt?

As Korea's household debt continues to rise, so too has the intensity of the debate surrounding

the severity of the problem. Regardless of one's views, there should be no question that it

warrants serious attention, especially since excessive household debt has shown its potential to

grow unattended, eventually causing serious shocks to the financial system and economy. As

the problem is complex, this article seeks to provide a brief overview while focusing in on

those areas that are easily unnoticed yet that harbor latent risks, such as loans to low-credit

households and self-employed individuals, as well as mortgages that are excessive in relation to

the incomes or repayment abilities of borrowers.

Wanjoong Kim, Fellow Warren Park, Senior Researcher

Despite attempts at regulation, Korea's household debt problem

continues to balloon

Korean household debt stood at ￦1,103

trillion as of the end of 2011.1) Though last

year's measures to curb household lending by

the banking sector succeeded in slowing the

rate of growth somewhat, the result has been

a shift in demand to the non-banking sector

(such as savings banks and credit coopera-

tives), where household lending has surged

as the quality of new loans has declined.

To deal with this unintended effect, the

government has been discussing plans to re-

strain household lending by non-bank finan-

cial institutions. Such an approach creates

another set of problems, however, partic-

ularly since much of the recent growth in

household debt has gone to people with low

credit ratings in the form of unsecured loans.

Given that they typically do not qualify for

bank loans, restricting lending by the

non-bank sector would leave them without

viable sources of credit, thereby making it

harder for them to make ends meet, and

hence pushing them further toward delin-

quency, default or other personal hardship.

As this example shows, papering over the

household debt problem in one sector can

cause it to pop up in another. Because

household debt has grown into a complex

and multi-faceted problem, however, devising

solutions will not be easy. Thus, it is crucial 1) Throughout this article, the term "household debt" refers to "personal financial debt," as defined by the Bank of Korea, and which includes

pure household debt, debt held by self-employed individuals, and debt held by non-profit organizations.

12


[Figure 1] Household Debt Outstanding and as a Percentage of Disposable Income

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Household Debt (\tn) 535.8 561.8 586.1 647.1 717.2 795.3 868.1 930.6 1,011.0 1,103.5

(Growth Rate, %) 4.8 4.3 10.4 10.8 10.9 9.1 7.2 8.6 9.1

Nominal GDP 720.5 767.1 826.9 865.2 908.7 975.0 1,026.5 1,065.0 1,172.8 -

HH Debt/Nom. GDP 74.4 73.2 70.9 74.8 78.9 81.6 84.6 87.4 86.2 -

HH Debt/DI 1.31 1.27 1.23 1.29 1.38 1.46 1.50 1.55 1.58 -

Note: HH (Household) Debt refers to the "Personal Financial Debt" category of BOK; DI = Disposable Income

Source: Bank of Korea (BOK), Hana Institute of Finance

that the government and the financial sector

acquire a better understanding of this prob-

lem so that they can devise appropriate

measures that move beyond short-term rem-

edies and attempt to resolve the problem in

a comprehensive manner that encourages

gradual, rather than abrupt, deleveraging in

the household sector.

Why has Korea's household debt

grown so much and so quickly?

The ongoing and rapid growth in Korea's

household debt can be attributed to a variety

of factors, including the sharp increase in

self-employed people － a trend that finds its

origins in the wave of layoffs stemming

from the Asian financial crisis; intense com-

petition among domestic financial firms to

expand their lending; the low interest rate

environment that has been in place since the

early part of last decade; and growing de-

mand for residential mortgages spurred large-

ly by ever-rising housing prices.

From 2002 to 2011, Korea's household

debt grew by around 100%, much faster

than nominal GDP, which grew by only

70%. The result has been a rapid and pro-

nounced increase in the ratio of household

debt to annual income. As of the end of

2010, for example, the ratio of household

debt to disposable income stood at 158% － higher than most major economies.

Policy measures have only delayed the problem; a more fundamental

solution is needed

Since the global financial crisis, many

major economies have experienced some de-

gree of deleveraging, with household debt ei-

ther slowing or outright declining. Korea's

household sector, however, has not experi-

enced such a deleveraging. This is largely

13

Issue

[Figure 2] Growth in Household Lending by

Non-Bank Institutions

[Figure 3] Comparison of Rates on Bank and

Non-Bank Unsecured Loans by Credit Rating

8.5

17.9

23.521.1 21.7

33.7

0

10

20

30

40 (%)

Banks Non-Banks

FinanceCo's

MutualCredit

SavingsBanks

Comm.CreditCoops

Growth in Household Lending(1/1/2010 - 6/30/2011)

0

5

10

15

20

25

30

35

1 2 3 4 5 6 7 8 9 10

(%) BanksNon-Banks

Credit Rating → LowerHigher ←

1~4Avg. = 11%

5~6Avg = 15%

7~10Avg = 17%

Source: BOK Source: BOK

due to the constant efforts of the government

to stabilize housing prices － by relaxing

rules on mortgage loans, which account for a

majority of household debt; easing regu-

lations on housing construction; or providing

tax incentives for homebuyers. For its part,

the financial sector has followed the gov-

ernment's lead in prolonging the household

debt problem. In the wake of the global fi-

nancial crisis, for example, Korea's lenders

extended the interest-only grace periods and

maturity schedules on most mortgage debt,

giving borrowers more breathing room but

doing nothing to induce a gradual

deleveraging. So while such actions by the

government and financial sector have pre-

vented a disorderly deleveraging thus far,

they have also caused the household debt

problem to grow larger and potentially more

difficult to manage in the future.

Korean household debt's potential stress points lie in three main areas

To better understand where the greatest

risks in Korea's household debt problem lie,

it can be helpful to focus on three sub-sec-

tors: (1) loans to low-credit households, (2)

loans to the self-employed, and (3) structural

weaknesses inherent in Korea's home

mortgages.

As mentioned above, non-bank loans to

households with low credit ratings have been

surging recently － a problem because they

carry very high rates of interest.2) Notably,

outstanding loans to low-income households

(annual income of ￦20 million or less) ac-

count for only around 12% of household

debt outstanding, but they accounted for 37%

of the growth in household loans from the

beginning of 2010 through June 2011.

2) Assuming the same credit rating, the average rate in the banking sector on unsecured loans is 9.8%, whereas it is 24.8% in the non-banking sector － a difference of around 2.5 times. The spread widens even more for individuals with lower credit ratings.

14


[Figure 4] Average Annual Growth Rate in

Disposable Income and Sources of Income

[Figure 5] Comparison of Debt Held By

Self-Employed and Employed Households

11.8

5.7

12

7.3

4.2

10.9

1.3

16.3

0

3

6

9

12

15

18

1990-1999 2000-2009

Disposable Income

Employment Income

Investment Income

Self-Employment Income

(%)Self-Employed

HouseholdsEmployed

Households

Share of Households that Hold Debt

74.2% 70.6%

Average Debt \113.95mn \71.94mn

Debt as Percentage ofFinancial Assets

1.33x 0.83x

Debt as Percentage ofTotal Assets

0.23x 0.22x

Debt as Percentage of Disposable Income

2.57x 1.67x

Source: BOK, Statistics Korea Source: BOK, Statistics Korea

Considering that the majority of low-credit

households are also low-income, their pay-

ment burdens could become unsustainable,

leading to rising delinquencies or losses for

the non-bank sector.

The growth in loans to Korea's self-em-

ployed also poses potential risks. To illus-

trate, Korea has an unusually large self-em-

ployed population － 31.3% of the labor

force versus an average of 15.8% in OECD

countries － and the sector accounts for a

large portion of the recent surge in house-

hold debt. This can be a problem because

stagnant domestic demand has forced many

of them to borrow money for working capi-

tal purposes, even though they tend to have

more debt per financial assets or disposable

income than regular workers. Such conditions

may make it more difficult for them to

make debt payments in the event of econom-

ic or financial distress.

Mortgages remain the elephant in

the room

Of course, the greatest sources of vulner-

ability in Korea's household debt dwell with-

in the residential mortgage market. Given

that the surge in housing prices that began

in the early 2000s has been correlated with

the rapid growth in home mortgage, it is

likely that the housing market will serve as

a key barometer in the direction of house-

hold debt going forward.

The main problem with Korea's mort-

gages lies in their structure, as they have

tended to be mostly variable rate and bul-

let-type, which leaves borrowers particularly

vulnerable to rising interest rates or the ma-

turity of principal. Although recent efforts

have lowered the percentage of total mort-

gages that are bullet-type, they still comprise

39% of outstanding mortgages. For the rest

15

Issue

[Figure 6] Loan Amount as Share of Income and

Share of Overborrowers

[Figure 7] Average Loan Amounts Before and

After DTI Regulations by Amount of Collateral

17.1

27.4

48.5

38.5

189

360

285

255

0

10

20

30

40

50

60

\300mn orBelow

\300-600mn

\600-900mn

Above\900mn

(%)

0

100

200

300

400(%)Percentage ofOverborrowers (L)Loan Amount/Income (R)

67 .8

102 .2

136 .6

208 .7

53 .6

117 .4

186 .7

294 .9

0

50

100

150

200

250

300

350

300mn orBe low

\300-600mn

\600-900mn

Above900mn

(\mn) After DTIRegulationsBefore DTIRegulations

Source: Kis-value, Hana Institute of Finance Source: BOK, Statistics Korea

of mortgages that are amortized, 84% are

still in their grace period and thus require

interest payments only.

Once borrowers are required to make

principal payments, however, the structural

weaknesses of Korea's mortgage market will

become more evident. According to the most

recent Survey of Household Finances, 31%

of households that hold bullet-type mortgages

say they will be unable to repay the princi-

pal upon maturity, while 23% say they will

need to sell their home in order to pay off

their mortgage. Thus, if the maturities are

not extended or underlying homes cannot be

readily sold, there could be a rise in mort-

gage delinquencies or defaults.

Korea's mortgages are closely tied

with a variety of potential risks

Although it had been assumed by many

that high-income households would be im-

mune to household debt issues, there is evi-

dence to suggest that a portion of them may

be vulnerable to maturing bullet-type struc-

tures or because they borrowed excessively

in the past for speculative purposes. In par-

ticular, recently released data show that, in

the years leading up to the global financial

crisis, the higher the price of the home, the

more these speculative borrowers took out in

mortgages relative to income. The data also

show that debt-to-income ratios increased as

the prices of underlying homes increased, but

fell after DTI regulations were introduced in

2006. This suggests that these regulations

were helpful in stemming a fair amount of

speculative demand.

16


There is also the issue of the sizable por-

tion of homebuyers who combined mortgages

with jeonse funds (lump-sum deposits in lieu

of monthly payments) received from

long-term renters to make their purchases.

Although the official LTVs on such mort-

gages appears to be relatively low, if the

two sources of funds are combined, it is es-

timated that such LTVs would exceed 80%.

Thus, there could be more risk in such

structures than is evident in official LTV

ratios.

On a somewhat longer-term basis, the ag-

ing of Korea's population could be another

latent risk. Retired households in Korea have

over 90% of their assets tied up in real es-

tate, so many retired households do not have

adequate financial assets for retirement.

Herein lies a potential vulnerability, as this

lack of funds for retirement expenses could

force a portion of retirees to sell their homes

in the event of a significant drop in housing

prices.

Conclusion and Recommendations

Recently, ongoing stagnation in the hous-

ing market, particularly the Seoul Metro

Area, has stirred some politicians to make

the case for looser DTI regulations to stim-

ulate the housing market. As we have seen

before, however, such measures may support

the housing market and improve conditions

for related industries, but the effects are like-

ly to be short-lived and will do no more

than kick the problem down the road again.

Instead of makeshift measures, the gov-

ernment will need to collaborate with finan-

cial institutions in devising a more compre-

hensive, longer-term approach based on a va-

riety of measures. For instance, they will

need to find better ways of shifting mort-

gage borrowers from variable-rate loans to

fixed-rate loans. They also need to induce

more borrowers to begin paying down their

mortgage principal, while at the same time

making it more difficult for borrowers to re-

finance into mortgages with interest-only

grace periods. They also need to find ways

of bolstering housing transactions and ex-

panding the use of reverse mortgages for the

elderly. Finally, financial institutions will

need to strengthen their own risk manage-

ment and work to slow the surge in house-

hold debt, with greater emphasis on

long-term profits and sustainability.

Although none of these measures alone

will solve the household debt problem, a

combination of them, if well designed and

executed, could go a long way in ensuring a

steady reduction in household debt. The

sooner such bold measures are taken, the

better.

17

Issue

Korea's Real Estate Project Finance Market: Diagnosis and RemediesSince 2010, Korea's financial sector, especially the banking industry, has stepped up its efforts

to manage troubled real estate PF loans. Rather than eliminating the risks, however, the

unintended result has been the gradual transfer of such risks away from the financial sector,

but into the construction industry. Thus, to get to the root of the problem and ensure that

the gradual elimination of PF-related risk in the financial sector results in greater liquidity for

constructions firms, it would be helpful to expand the use of alternative methods such as

public-private partnerships. There is also a need to diversify methods of financing real estate

development projects so that participants share associated risks more evenly.

Jeungrak Sohn, Senior Researcher

[Figure 1] Unsold Housing Units and Home

Prices by Region

[Figure 2] Real Estate PF Lending in the

Financial Sector

-5

0

5

10

15

20

25

2007 2008 2009 2010 2011-5

0

5

10

15

20

25Unsold RegionalHousing Units (R)Unsold SMA HousingUnits (R)Home Prices in Top 5Cities (ex-SMA)Home Prices in SMA

(YoY,%) (10 ,000 Units)

0

20

40

60

80

100

2008 2009 2010 2011.30

3

6

9

12

15

Sec Firms/Asset ManagersInsuranceSavings BanksBanksDe linquency Rate (R)

(\tn) (%)

Source: MLTM, Bank of Korea

Note: Excludes KAMCO's \7.4tn purchase of PF loans

Source: FSS

As housing remains mired in slug-gishness, risks from deteriorating real estate PF loans are cause for

concern

In Korea's real estate development market,

the main source of funding for land and

construction costs has been project finance

(PF) loans, which are granted by financial

institutions to construction companies based

on their credit standing. Since most of these

projects are in the housing sector, their prof-

itability and stability tends to depend largely

on pre-sales of housing units.

18


[Figure 3] Real Estate PF Securitization: Amount

Outstanding and New Issuance

[Figure 4] Housing as a Share of Total Real

Estate PF Securitization

0

5

10

15

20

25

30

35

2008 2009 2010 2011.3

ABCP Outstanding

ABS Outstanding

ABCP Issuance

ABS Issuance

(\tn)

0

2

4

6

8

10

09 .1H 09.2H 10 .1H 10.2H 11.1H0

20

40

60

80

100Real Estate PFSecuritizationHousing Share (R)

(\tn) (%)

Source: FSS, Korea Investors Service Source: NICE

Since the global financial crisis, a

drop-off in housing demand has resulted in

ongoing market weakness in the Seoul Metro

Area (SMA), with housing prices decelerat-

ing significantly. As the slowdown has con-

tinued, potential risks stemming from real es-

tate PF loans have increased significantly. In

fact, delinquencies on real estate PF loans

have surged from just 4.4% as of end-2008

to 12.3% in March 2011.

This surge in delinquencies has occurred

despite the fact that, since 2010, the finan-

cial sector, particularly the banking industry,

has made significant progress in reducing its

exposure to real estate PF loans, as part of

its efforts to strengthen risk management and

enhance asset quality. As a result, the out-

standing amount of real estate PF loans from

the financial sector has decreased from ￦83

trillion as of the end of 2008 to ￦59 trillion

at the end of March 2011.

Financial institutions have been call-ing in real estate PF loans, ex-acerbating the liquidity crisis in the

construction industry

As a result of financial institutions calling

in existing PF loans and holding back on

new loans, the second half of 2009 wit-

nessed the beginning of a surge in con-

struction companies' use of direct financing

in the form of securitizations such as ABS

or ABCP. Indeed, such securitization out-

standing grew from ￦9.3 trillion at the end

of 2008, to ￦12.5 trillion at the end of

2009, to ￦16.8 trillion at the end of 2010.

Since the beginning of 2011, however,

there has been a clear decline in the issu-

ance of real estate-related ABS and ABCP,

leaving construction companies with few op-

tions in accessing much-needed liquidity.

19

Issue

[Figure 5] The RTC's Asset Liquidation Method[Figure 6] Liquidation Methods for Land and

Development Project Assets

AssetType

ResidentialCommercial/Multi-Unit Housing

REO3) Non-Investment Grade Securities

1.

CategoryBook Value

Appraised Value

ActualCollections

Recovery Rate

IncomeProducing

Assets

Securi-tization

☞Asset Sales☞Securitization☞Partnerships

☞Asset Sales☞Partnerships

☞Asset Sales☞Sales to Issuer☞Asset

Exchanges/ Auctions

Partner-ship

NPSeries

537 119 145 122%

LandFunds

2,218 640 592 93%

Asset Sales

Bulk Sales 1,057 306 279 91%

Non-Income

Producing Assets

Partner-ships

☞Asset Sales☞Partnerships

Auctions 259 163 122 75%

Sealed Bidding

407 NA 122 NA

Note: Asset sales include individual loan sales, bulk sales,

auctions and sealed bidding

Source: Hyuna Kim, Sangyoung Lee (2011)

Note: Unit = $mn

Source: FDIC (1998), "Managing the Crisis," pp. 450~451

Since a large share of real estate securiti-

zation is related to housing, and the housing

sector remains sluggish, there are growing

concerns about whether such bonds will be

able to be rolled over. Since 2009, 25 of the

largest 100 domestic construction firms have

applied for workouts or court receivership,

demonstrating how deteriorating liquidity

conditions have caused construction company

insolvencies to increase, thereby magnifying

potential risks.

Bad-debt disposal capabilities must be strengthened to enhance liquid-

ity in the construction industry

The construction industry has been taking

measures to improve liquidity conditions; for

example, by selling assets at 10-30% below

initial asking prices. But liquidity conditions

could still deteriorate further. To illustrate,

outstanding PF-related contingent liabilities of

construction companies connected to existing

projects alone amount to around ￦19.5 tril-

lion in the Seoul Metro Area and ￦6.8 tril-

lion in other regions.

Because of the possibility of further asset

deterioration, it is not easy for the private

sector to provide additional liquidity. Thus,

the publicly-funded Korea Asset Management

Corporation (KAMCO) and the United Asset

Management Company (UAMCO) have been

purchasing non-performing real estate PF

bonds with the dual goal of enhancing asset

quality in the financial sector and providing

liquidity to the construction industry.

Unfortunately, most of the purchases have

been from the financial sector, and the scale

of buying has been limited, with KAMCO

3) REO ("Real Estate Owned") refers to real estate that has become a possession of the lender after a borrower has defaulted.

20


and UAMCO purchasing a total of ￦7.4 tril-

lion and ￦1.2 trillion worth － a relatively

small portion of total PF debt. It would

therefore be helpful if these public asset

management companies acquired more

non-performing debt from the financial sector

and promoted the sale of such assets in the

market, thereby enabling the financial sector

to provide greater liquidity support to the

construction industry.

The experience of the RTC in the US can provide a useful model for the

resolution of bad PF debt

In the late 1980s, the Resolution Trust

Corporation (RTC) was formed in the United

States as a means of taking over the bad

debts of insolvent S&L associations and dis-

posing of them. The RTC used a variety of

methods for such liquidations, including as-

sets sales, securitization, and public-private

partnerships. Of particular note was the

RTC's use of the partnership format for the

disposal of the thrifts' bad debts － a method

which the RTC pioneered. Using this meth-

od, the RTC established a fund with private

investors, purchased distressed assets, and al-

located the profits from their disposal among

investors. Private investors involved in the

partnerships included financial institutions, in-

stitutional investors and real estate

developers.

In all, the RTC established 72 separate

partnerships and disposed of $21.4 billion in

non-performing assets, and the partnerships

were particularly useful in disposing of

non-income-producing assets that are difficult

to price, such as land and development

projects. Through the use of a variety of liq-

uidation methods and the expanded invest-

ment from the private sector, the RTC was

able to dispose of the assets of insolvent

thrifts on a large scale in a relatively effec-

tive manner. In fact, the RTC's recovery rate

on land and development assets was around

75-122% of their appraised value.4)

The use of partnerships should be expanded to support construction companies' liquidity needs and

growing amounts of distressed debt

In Korea, KAMCO has plans to diversify

the disposition methods of distressed PF sites

through the use of partnerships with financial

institutions, construction companies and real

estate developers, but the scale of such ef-

forts remains very minor. Of the 338 PF

sites that it has purchased from savings

banks, only ten have been handled through a

partnership format.

4) In valuing non-income-producing assets, the RTC applied Derived Investment Value (DIV), subtracted operating costs from the value, then applied a 12-25% discount in determining the price.

21

Issue

The benefits of a public-private partner-

ship format are twofold: First, given that the

market remains downtrodden, it is difficult

for the private sector to dispose of distressed

assets alone. Second, there is a limit in the

amount of public funds available. Thus, in

order to provide more liquidity to con-

struction companies while strengthening the

level of preparedness against a potential in-

crease in distressed PF loans, the private

sector will need to take on an expanded role

through efforts such as public-private

partnerships.

The industry needs to develop new structures to replace the PF method

of financing real estate development

Since the global financial crisis, the de-

mand for real estate has declined and poten-

tial project participants have become more

risk-averse. Considering that project financing

relies heavily on pre-sales of housing units

and the credit standing of construction com-

panies, the result has been a slowdown in

project financing. In response, there have

been ongoing efforts to incorporate new

structures into development deals, such as

having financial institutions play the leading

role in development projects, establishing

large developers or self-managed develop-

ment REITs, or establishing investment funds

specialized in real estate development.

However, because the real estate market re-

mains sluggish, and there are no wide-reach-

ing mechanisms for diversifying or alleviat-

ing the risks of projects, the search for a

clear alternative continues.

Developing new business models and diversifying financing methods

could help reduce risks

To cope with the growing uncertainty and

volatility in the real estate market, there is a

need to develop new business models that

can help ensure stable cash flows throughout

the development process. Since cash flows

come mainly from two sources － revenue

and financing － there is a need to develop

business models that seek to diversify sour-

ces of revenue as well as financing methods.

One way of achieving this is to ensure that

investors play a larger role in the develop-

ment process.

Regarding diversification of revenue, de-

velopers would be well-served to change

their business plans by placing less reliance

on housing, which tends to rely on upfront

income from pre-sales, and focusing more on

developing real estate that generates rental

income, such as office buildings, retail space

or hotels.

22


[Figure 7] Private Sector Efforts to Diversify the Structure of Development Projects and Project Financing

Major Trends

Banks

Cutting back on real estate PF lendingInvesting more conservatively (reduce amounts invested in development projects, strengthen ability to conduct feasibility analyses)Disposing of distressed PF loans through, for example, the establishment of "bad banks"

InstitutionalInvestors

Securities firms and insurance companies are reducing lending and strengthening management of existing loans in response to a spike in loan delinquenciesSelectively investing equity in and directly managing development projectsParticipating in the public-private co-development partnership program led by KAMCO

Construction Companies

Industry restructuring underway, with 25 of the largest 100 construction companies applying for workouts or court receiverships since 2009After reduction in PF lending by financial institutions, increasingly issuing securitized products such as ABS or ABCP for financingIncreasingly obtaining third-party payment guarantees to reduce risks from development projects

Real Estate Developers

Working to establish larger development companies with advanced RE development capabilities (asset management plus asset development, etc.)Investigating new business structures such as self-managed development REITs and real estate trustsSome corporations that own real estate are working to establish an RE development companySeveral overseas-based real estate funds are considering entering Korea's RE development market

Source: Hana Institute of Finance

As for diversification of financing meth-

ods, expanding the use of partnerships be-

tween professional investors and landowners

would be effective. The use of partnerships

can be helpful in enhancing the overall sta-

bility of a real estate development project,

especially in the initial stages, as it can re-

duce the required amount of development

capital by letting landowners invest their

land in exchange for equity in the project.

When developing commercial real estate,

for which cash flows can be valued, it can

be helpful to utilize long-term mortgage

loans that pay for construction costs on an

incremental basis using operating income as

collateral.

Finally, it would be advisable to establish

investment funds that specialize in real estate

development, such as certain private equity

real estate funds in the US or Europe, as

this will help to strengthen investment ex-

pertise by enabling more active involvement

by a group of professional institutional

investors.

23

Issue

Big Changes Afoot for Korea's Financial Industry

After many years of struggle and failed attempts, Lone Star has finally succeeded in offloading

its stake in Korea Exchange Bank (KEB) to Hana Bank, which hopes its acquisition will help it to

realize its ambitions of becoming a much larger player in Korean banking. Meanwhile,

Nonghyup has split itself into two holding companies: agribusiness and financial services; this

should free it up to be more aggressive in expanding its bank and non-bank financial

subsidiaries. These seismic shifts, along with the removal of KDB and IBK from the list of public

institutions, suggest that Korea's financial services industry is in for major structural changes

that will have a significant impact on the competitive dynamics of Korea's financial sector.

Jaeman Song, Associate Researcher Warren Park, Senior Researcher

Recent events could have a tremen-dous impact on the competitive

landscape of Korea's banks

Banks around the world are facing a host

of uncertainties fueled by the ongoing crisis

in Europe, sweeping regulatory changes, and

other factors. Likewise, Korean banks face

their own challenges, namely fierce competi-

tion within a crowded domestic banking mar-

ket, low net interest spreads, and public

pressure on banks to lower various fees. In

response, they have been actively pursuing

means of expanding their revenue sources by

diversifying into new lines of business and

expanding overseas.

Against this backdrop, there has been a

series of events recently that could have a

considerable impact on the industry. In par-

ticular, Hana Financial Group has acquired

Korea Exchange Bank (KEB), giving it

greater market share and competitive power,

while Nonghyup Agricultural Cooperative

Federation (NACF) has separated its agri-

business operations from its financial busi-

nesses, which have been grouped together in

a newly formed financial holding company.

In other news, Korea Development Bank

(KDB) and Industrial Bank of Korea (IBK)

have been taken off the list of public in-

stitutions, thus granting them more autonomy

in their operations. These changes suggest

that competition in the banking and

non-banking financial industries is about to

heat up; it will be interesting to see how

these changes impact the competitive land-

scape of Korea's financial sector.

24


[Figure 1] Total Assets of Korean Banks [Figure 2] Domestic and Overseas Branches

260.1 258.7233.5

220.4

156.4

102.3

0

100

200

300

KB Hana (+KEB)

Woori Shinhan Hana KEB

(\tn)

1,156

1,007 966 932

11 38 19 220

200

400

600

800

1,000

1,200

1,400

KB Hana + KEB Shinhan Woori

Domestic

Overseas

Note: Total Assets are as of end-September 2011.

Source: FSS Source: FSS

The merger of Hana and KEB creates

a new giant in the industry

For the past few years, KB, Woori,

Shinhan and Hana were considered to be the

"Big 4" banks, accounting for 63.8% of do-

mestic deposits. In reality, though, Hana

placed a distant fourth, as its total assets

were about ￦80 trillion less than Shinhan

(#3); this is why many industry observers re-

ferred the Big 4 as the "Big 3 and 1

Medium." Now that Hana has acquired KEB,

however, the combined bank has total assets

of ￦258.7 trillion － a close second only to

KB, which has ￦260.1 trillion in assets. In

addition, the combined entity now has 1,007

branches, second only to KB's 1,156, thereby

enabling it to leverage a much larger retail

network. Thus, with four banks now in the

true Top 4, it seems inevitable that competi-

tion in the industry will heat up.

Initial analysis of Hana Financial Group's

acquisition of KEB suggests that it was a

sound strategic move, since Hana Bank can

merge its strengths in retail banking with

KEB's strengths in foreign exchange and

trade finance, enabling each bank to fill gaps

in the other's businesses and thereby generate

synergies. In particular, Hana Bank, which

has been accelerating its overseas expansion

efforts, will try to leverage the overseas

branch network of KEB in order to give it-

self expanded global reach. The combined

entity will have 38 branches in 22 countries,

by far the most of any Korean bank. In ad-

dition, through its acquisition of KEB, Hana

Financial Group's overseas assets now top

￦36 trillion, placing it ahead of other

Korean financial groups such as Woori (￦22

trillion) and Shinhan (￦19 trillion).

25

Issue

[Figure 3] Key Indicators for Major Credit Card

Companies in Korea

[Figure 4] Total Assets of Korea's Financial

Holding CompaniesTotal Assets(Avg.)

Purch. Vol.

\(tn)

Market Share(%)

Customer Accounts

(mn)

Merchants(mn)

372.4 366.5 363.6337.3

240

0

100

200

300

400

500

Woori Hana KB Shinhan NH

(\tn)Shinhan

Card21.9 95.2 22.94 15.43 264

KB Card 12.8 57.7 13.90 10.40 212

Samsung Card

15.7 53.4 12.86 10.81 244

Hyundai Card

9.6 52.4 12.63 9.30 191

HanaSK +KEB Card

8.0 34.5 8.29 10.77 249

HanaSK

5.6 21.8 5.24 7.22 40

KEB 2.4 12.7 3.05 3.55 209

Note: Data cover period from 1/1/2011 to 9/30/2011

Source: FSS, CREFIA, Individual company data

Note: Total Assets includes trust accounts

Source: FSS, Company Data

In the credit card business, the tie-up be-

tween HanaSK Card, which has a weak cus-

tomer base and does not have its own pay-

ment network, and KEB Card, which has its

own payment network with over two million

merchants, will give the combined entity a

market share of around 9%. The combination

should generate significant synergies and

give rise to a stronger competitor to current

market leaders Shinhan Card and KB Card.

Of course, making the merger a success

will require strong organizational planning

and management. Though Hana Financial

Group has granted KEB the right to main-

tain its brand and retain the bulk of its per-

sonnel, it must still work to integrate the

management and cultures of the two organ-

izations － a crucial yet formidable task. To

move in the right direction, HFG and KEB

will need to develop measures to enhance

mutual understanding at the cultural and or-

ganizational level. Also, given that the banks

have agreed to maintain a "two bank" struc-

ture (two separate banks under one financial

holding company) for at least five years,

Hana Financial Group may need to make

some modifications to its matrix organiza-

tional structure.

The split-up of Nonghyup will create

a new financial holding company

Along with Hana's acquisition of KEB,

the other main event in the financial industry

in the first quarter of 2012 was the separa-

tion of the financial and agricultural busi-

nesses of Nonghyup (NCAF), which has led

to the creation of the NH Financial Group.

Historically, Nonghyup has been known pri-

26


[Figure 5] Nonghyup's Structure Before & After the Separation of Its Agricultural & Financial Businesses

Source: Hana Institute of Finance

marily for its agricultural business. But as

the financial side of the company expanded,

there were increasing calls for the separation

of the two areas of business, with the idea

first proposed in 1994. It was not until

March 2, 2012, however, that Nonghyup fi-

nally split itself and relaunched as two sepa-

rate holding companies. The financial side of

the business, NH Financial Group, has total

assets of ￦240 trillion, ranking it fifth be-

hind the financial groups of Woori, Hana,

KB and Shinhan.

Before taking on its new form, NACF

comprised four businesses: Education &

Support, and the Agricultural, Livestock and

Credit businesses. Under the new system,

however, it is composed of two separate

holding companies (Agribusiness and

Financial Business), as well as Education &

Support and Credit. Under the new structure,

NH Agribusiness Group will handle agricul-

tural supply and distribution, whereas NH

Financial Group will handle financial serv-

ices through subsidiaries such as NH Bank,

NH Life, NH Fire, NH Securities, NH

Futures, NH Asset Management and NH

Capital.

NH Bank has traditionally raised funds in

urban areas and used them to provide fi-

nancing, education and other types of sup-

port to farming and agriculture in rural

areas, where it is most needed. Through its

extensive rural network, it has built holdings

of ￦195 trillion in total assets and 1,172

outlets. If its cooperative banking business,

which is technically not part of the banking

sector, is combined with its banking oper-

ations, Nonghyup's holdings rise to ￦450

trillion in assets and 5,600 outlets. Thus, it

can be considered a powerhouse in Korea's

financial industry.

27

Issue

One factor that distinguishes Nonghyup

from the pack is its strong nationwide net-

work of banking outlets even in rural areas,

whereas other major banks have their

branches concentrated mainly in the Seoul

Metro Area. Nonghyup's nationwide reach

ensures that it has the scale necessary to be

a formidable competitor to other top banks.

In particular, it could become a legitimate

threat to leading banks if it expands its

branch network in the Seoul Metro Area.

Nonghyup's new structure is also expected

to benefit NH Life, whose ￦33 trillion in

assets already puts it in fourth place among

life insurers, but whose new identity as part

of a financial holding company gives it the

ability to utilize the bancassurance channel

of Nonghyup's nationwide network of

branches. This is expected to change the

competitive landscape of the industry.

However, if Nonghyup is to follow in the

footsteps of a company like Credit Agricole

－ which grew from an agricultural coopera-

tive into a global player, and which is often

seen as a role model for Nonghyup's finan-

cial ambitions － its subsidiaries such as NH

Bank and NH Life will need to overcome

some important challenges.

For example, NH Bank is less productive

than other banks, as shown by its per-em-

ployee assets of ￦14 billion, deposits of

￦10.4 billion, and loans of ￦9.5 billion. Its

risk management capabilities are also consid-

ered less developed than other banks, and its

IT systems have frequently been faulted for

provide unstable service.

NH Life's main weakness is the size of

its salesforce, which it will need to expand

in order to increased its sales of highly prof-

itable guarantee-type products. Currently, it

only has around 1,500 sales advisors, even

less than many medium-sized competitors.

Contrast that with Samsung Life, which has

38,000; Daehan Life, which has 25,000; and

Kyobo Life, which has 23,000. NH Life will

also need to provide its salesforce with on-

going education and training.

Removing KDB and IBK from the list of public institutions will give them

more autonomy

In other news, the Korea Development

Bank (KDB) and the Industrial Bank of

Korea (IBK) have been taken off the list of

public institutions, a move that should enable

them to make more managerial decisions that

are independent of government oversight. For

example, it grants them more freedom in

making personnel decisions. It also gives

them more freedom to expand their retail or

investment banking operations.

28


[Figure 6] NH Life's Position in the Industry [Figure 7] Change in SME Loans by Bank Type

0

40

80

120

160

Samsung Daehan Kyobo NH ING M irae0

5

10

15

20

25

Total Assets (L)

Insurance Premiums (R)

(\tn) (\tn)(Unit: \tn) 2006 2007 2008 2009 2010

Commercial Banks

30.8 50.6 30.9 7.7 -5.4

Special Banks

14.2 17.4 22.5 13.4 3.0

PolicyBanks

10.9 11.2 12.6 12.6 5.8

IBK 10.1 9.0 7.6 10.4 5.2

Source: KLIA, NACF

Note: IBK, KDB and Korea Eximbank are policy banks

Source: FSS

However, removing these banks from the

list of public institutions could potentially

open another can of problems. Based on

their public charters, the two banks have

served a public purpose by lending to sec-

tors or projects that commercial banks do

not find attractive. IBK, for example, has

been a leading lender to SMEs, whereas

KDB has played a major role in financing

important public infrastructure or other devel-

opment projects. Now that they have been

taken off the public institutions list, however,

there is the risk that they could reduce their

public role, leaving SMEs and important

public initiatives with fewer credit options.

In order to avoid such a scenario, it would

be advisable to allow them to pursue their

commercial interests while also providing

them with incentives to maintain their im-

portant role as public-oriented lenders.

The outlook for Korea's banking in-dustry is fraught with ambitions and

uncertainties

With Hana's acquisition of KEB, the

competitive landscape of Korea's banking in-

dustry has changed from a Big 3 to a Big 4

structure, whereas NACF's split into agricul-

tural and financial businesses adds another

financial holding company to the mix and is

thus likely to transform the competitive land-

scape at the financial holding company level.

For KDB and IBK, their removal from the

list of public institutions should give them

more room to beef up their retail banking

operations, which should also raise the level

of competition in the sector.

As more financial holding companies en-

ter the competitive scene, they will continue

to diversify their business lines and expand

into new markets. In particular, as bank

29

Issue

profitability has stagnated recently, financial

groups are likely to continue their march in-

to non-banking financial sectors, while focus-

ing on operational and organizational re-

structuring to generate greater synergies be-

tween their banking arms and non-banking

subsidiaries.

Moreover, Korea's banks and financial

holding companies will continue to push into

overseas markets. Even though the ongoing

rush to expand into overseas is likely to be-

come more intensified, it is likely to benefit

Korea's banks in two major ways: First, be-

cause Korea is a small and open economy,

it remains vulnerable to external financial

shocks. Successful overseas expansion can

help Korea's banks to secure more stable

sources of foreign currency-denominated

funding, thereby providing Korea's financial

system with bolstered defenses against global

financial stability or external shocks.

Second, because of its small size, Korea's

banking market is plagued by lower growth

expectations as well as intensified

competition. As such, they will need to con-

tinue to seek out new sources of growth in

overseas markets.

30


Korea's Long-Term Solar Prospects Shine Bright

After growing at a steady pace through 2010, the global solar photovoltaic (PV) industry

deteriorated sharply in the second half of 2011 owing to a precipitous drop in European

demand combined with excess supply. Industry conditions will likely continue to worsen in 2012,

forcing the bankruptcy of many weaker companies, but an upturn in US and China demand

should allow the industry to recover in 2013. Moreover, technological advancements and the

pace of the recovery suggest that solar PV could reach grid parity as early as 2015, paving the

way to a high-growth phase. Korean solar PV companies, though laggards in the industry, still

have ample opportunity to compete as long as they invest for the long-term.

Hyeyoung Ahn, Senior Researcher

Market conditions in the solar PV in-dustry continue to erode

In the latter half of the 2000s, the eco-

nomics of photovoltaic (PV) power improved

as global PV manufacturers scaled up and

achieved greater vertical integration, enabling

the industry to grow at a blistering annual

average pace of 45% in the 2007-2010

period. This led to a sharp increase in facili-

ties investment around 2010, particularly in

China. Starting in the second half of 2011,

as Europe's woes spilled over into the global

economy and credit markets, however, the

demand for PV power declined precipitously,

causing oversupply conditions to worsen. As

a result, prices along the PV value chain

plummeted by 40-50% over the previous

year, leading to a drop in the capacity uti-

lization of the industry's major players and

significant deterioration in business conditions

overall.

An examination of the solar PV value

chain shows that companies furthest down-

stream took the greatest hit to profitability.

For polysilicon and ingot/wafer producers,

there have been concerns about potential

oversupply stemming from large-scale ex-

pansion of facilities, but considering that the

undersupply of such high purity materials is

expected to continue for a while, related

companies should be able to maintain rela-

tively stable profit margins.

Contrast this with the next link in the

value chain, solar cells and modules, where

already severe oversupply conditions have

31

Issue

[Figure 1] Prices Declines Across the Value Chain[Figure 2] Korea's Solar PV Technological

Sophistication Relative to Advanced Economies

0

0.4

0.8

1.2

1.6

2

P-Si Ingot/Wafer Cell Module

($/W)4Q 2010 4Q 2011

81.4

59.7

49

80.0

0

20

40

60

80

100

P-Si Ingot/Wafer Cell M odule

(%)

Source: Solar PV Green Forum 2011 Source: The Export-Import Bank of Korea

deteriorated further as the economic slow-

down has dented demand. This has thrown

supply and demand even more out of bal-

ance, causing prices and profitability to drop

sharply. Because of such deteriorating con-

ditions in the industry, some of the smaller

industry players that cannot compete on price

find themselves faced with the prospect of

bankruptcy, making a string of insolvencies

in the industry virtually inevitable.

Naturally, Korean PV-related companies

have not been spared from the global eco-

nomic slowdown and the generally deteriorat-

ing conditions in the PV industry, as those

most heavily dependent on exports have seen

growth diminish rapidly. The PV-related ex-

ports of such Korean companies grew at an

average annual pace above 100% in

2008-2010, but such growth is expected to

slow to around 20% in 2011-2013.

The PV market should begin to re-

cover in the second half of 2013

Based on the fact that government sub-

sidies for solar PV power have been reduced

and that European demand is expected to de-

cline by at least 2GW, as well as expect-

ations of slower global growth and limited

demand growth from new markets, over-

supply and falling prices in the PV industry

are likely to continue in 2012. Over the

short term, it is likely that plummeting pri-

ces stemming from excess supply will cause

failures among PV manufacturers unable to

compete either on technological prowess or

price. Beyond the short-term shock, however,

this sort of industry restructuring should help

to gradually ease excess supply conditions.

Plus, with demand in the US and China ex-

pected to increase gradually, the photovoltaic

industry could begin to recover in 2013.

32


[Figure 3] Trends in Share of Solar PV Production in the US and China Versus Europe

36.4

8.4

44.0

80.0

0

20

40

60

80

100

2006 2007 2008 2009 2010 2011E 2012E 2013E 2014E 2015E

(%) US+China Europe

Source: Solar&Energy

The US and China will likely play a leading role in the future solar PV

market

Thanks to solid and aggressive backing

by their respective governments, the photo-

voltaic industries in the US and China have

been growing at an explosive pace. In

China, the government has been active in

providing support to its solar-related compa-

nies for their R&D and facilities expansion,

while also raising ceilings on lending to

such companies. It is also planning to launch

a feed-in tariff system in July 2012, provid-

ing further hope that China's domestic PV

market will be able to grow at a rapid pace.

Considering these types of measures out of

China, it is forecast that the PV installed ca-

pacity in China will grow from 0.5GW in

2010 to 7.0GW in 2015, an annual growth

rate in excess of 70%.

In the United States, the country's vast

supply of desert and other low-cost land can

enable US-based companies to enter the in-

dustry with relatively low initial investment.

Moreover, as the cost of installing PV gen-

eration facilities has fallen recently, various

tax benefits and Renewable Portfolio

Standards provided by the federal and state

governments should help to spur growth, fu-

eling an increase in investment and demand

in 2012. Given these conditions, the United

States' installed PV capacity, which stood at

0.8GW in 2010, is likely to grow by an

average annual rate of about 80% until 2015,

by which time it should reach 8.8GW.

Based on these factors, it appears that the

solar PV markets in the US and China could

experience explosive growth, leading to a

shift in PV leadership from Europe, which

was the previous leader, to the US and

China. In fact, it is forecast that the com-

33

Issue

[Figure 4] Outlook for Solar PV Installed Capacity

2.46.3 7.6

16.619.0

23.0

28.0

34.0

41.0

0

10

20

30

40

50

2007 2008 2009 2010 2011E 2012E 2013E 2014E 2015E

(GW)

Source: Solar&Energy

bined share of global PV installed capacity

in the US and China could grow from 8.4%

in 2010 to 36.4% by 2015.

Once grid parity is achieved, the in-dustry should enjoy explosive

growth starting around 2015

Owing to the recent sharp fall in the pri-

ces of photovoltaic products, the cost of PV

power generation is beginning to approach

levels indicating grid parity.5) But because

the recent price drop is most likely due to

oversupply as opposed to technical advances

or cost reductions, it is probably temporal in

nature. As such, absent government subsidies,

PV power is still unable to compete on price

with existing grid power.

True grid parity within the solar PV in-

dustry can only be achieved when price

competitiveness is achieved through cost re-

ductions under stable supply-demand

conditions. Based on current PV technologies

and the industry's pace of recovery, grid par-

ity could be achieved as early as 2015.

Once solar PV does achieve grid parity, the

demand for PV power will likely increase by

at least fivefold, so the rapid growth phase

for the industry can be expected to begin

sometime around 2015.

As the solar PV industry is still young, Korean firms still have to

chance to get into the game

As latecomers to the industry, Korea's so-

lar PV companies still lag behind their rivals

in Europe and Japan in terms of technology,

and their rivals in China in terms of price.

Nevertheless, considering that the long-term

growth prospects for the industry are vir-

tually guaranteed, it will be important for

5) Grid parity is the point at which the price of generating power using a renewable energy is equal to or less than that of fossil fuels, absent government subsidies.

34


Korean firms to take a long-term view of

the industry and invest accordingly in a se-

lective and strategic manner, rather than bas-

ing their investment decisions on cyclical

changes or trends.

In the case of large firms, rather than

trying to achieve vertical integration immedi-

ately, they should focus investment first in

those areas where they are most competitive;

once they have gained a competitive foot-

hold, they can strategically aim for vertical

integration. Moreover, the recent deterioration

in the industry and its negative impact on

the profitability of many US and Chinese so-

lar PV companies will probably force many

of them to go under. Thus, there should be

ample opportunity for some of Korea's larger

solar PV companies with substantial capital

to speed their entry into the market through

acquisitions of some of these companies.

For medium-size companies with techno-

logical prowess, rather than pursuing crystal-

line solar cells, which requires economies of

scale to compete, it would be advisable to

carve out a strategic position in the market

for thin-film solar cells, where the competi-

tion is not yet as severe.

Big changes in the structure of the

solar PV industry are expected

As downturn in the industry continues, a

good number of solar PV companies in

Europe, China and the United States will

likely fail in 2012. This will open up oppor-

tunities for those companies with a long-term

strategy to move in and either acquire some

of these companies or buy up major stakes

in order to achieve vertical integration or se-

cure needed technologies.

As long as the industry's long-term pros-

pects remain positive, it is likely that solar

PV companies will increase their investment

in new technologies and large-scale manu-

facturing facilities, which will further fuel in-

dustry growth. So just because the industry

is struggling at the moment does not mean

that it is down-and-out. On the contrary, the

industry's future looks rather bright.

35

Market Watcher

Interest Rates: Rates to be kept on hold for an extended period

Wanjoong Kim, Fellow

[Figure 1] Key Interest Rates [Figure 2] ECB Total Assets & Deposits

2.0

2.5

3.0

3.5

4.0

4.5

11.1 11.3 11.5 11.7 11.9 11.11 12.1 12.3

(%)

3Yr KTB91D CDPolicy Rate1Yr Bank Bond

0 .0

0 .8

1 .6

2 .4

3 .2

08.1 08.11 09 .9 10.7 11.5 12 .3

(\tn)

0 .0

0 .3

0 .6

0 .9(\tn)ECB Deposits (R)

ECB Total Assets (L)

2nd LTRO

1st LTRO

Source: FnGuide Source: Bloomberg

Even as uncertainty over negotiations on

the second Greek aid package caused jitters

in global financial markets, the ECB's LTRO

program and other quantitative easing by ma-

jor central banks helped to expand the sup-

ply of global liquidity, spurring a rise in the

risk-on trade. This was evident in Korea as

well, as foreigners increased their allocations

to domestic equity markets while selling

KTB futures, adding to upward pressure on

yields. But even though two rounds of

LTRO were effective in easing global finan-

cial turbulence, they have done little to ex-

pand the provision of credit, as a large por-

tion of the liquidity supplied to banks has

ended up as ECB deposits. Thus, the impact

of such measures on the real economy has

been limited, raising the likelihood that the

economic stagnation in the Eurozone will

continue for an extended period. Meanwhile,

in China, the risk of a hard-landing seems to

have diminished greatly, but given that the

National People's Congress (NPC) recently

announced that it had lowered its 2012

growth target to 7.5%, it appears that the

odds of a global economic slowdown are

rising.

Given the ongoing Eurozone crisis, global

economic slowdown, and heightened geo-

political risks in the Middle East, the Fed

has kept policy rates on hold since July

2011, and expanded global liquidity and im-

proving US economic indicators since

February have reduced expectations for a

lower Fed funds rate. If anything, geo-

political tensions in the Middle East could

36


[Figure 3] Residential Mortgages & HH Debt[Figure 4] Cumulative Net Purchases of KTB Futures

by Foreigners & Yield Trends

-4

-2

0

2

4

10 .1Q 10.3Q 11.1Q 11.3Q 12.1

(\tn)

Household Loans

Residential Mortgages

12.2

Annual Avg.\2.00tn

\1.82tn

Annual Avg.

-9

-6

-3

0

3

6

9 2.7

3.0

3.3

3.6

3.9

4.210.10 11.1 11.4 11.7 11.10 12.1

Cumulative Net Purchases ofKTB Futures by Foreigners (L)3yr KTB Yield (R)

(10,000 Contracts) (Reverse Axis, %)

Source: Bank of Korea Source: Thomson Reuters Datastream

cause oil prices to surge, thereby increasing

the need to hike rates. But despite improve-

ment in key economic indicators such as

manufacturing in China and the US, the

European crisis is likely to be prolonged and

the potential for an oil price spike remains,

making it more likely that the Korea's policy

rate will be kept on hold for a while.

In addition, reduced demand for mort-

gages stemming from slowing housing de-

mand and strengthened management of

household debt should lead to slower growth

in household lending, making it less likely

that the Monetary Policy Committee (MPC)

will hike rates, whereas its emphasis on the

importance of inflationary expectations makes

further easing unlikely.

Meanwhile, in addition to rising equity

prices and reduced risk aversion stemming

from expanded global liquidity, foreign in-

vestors continue to sell KTB futures, thus

exerting upward pressure on market rates.

Foreign purchases of Korean bonds, which

had been slowing since October 2011, have

shown a net increase since mid-February.

Because such purchases have been con-

centrated primarily at the short end of the

yield curve and in MSBs, however, their

most likely effect will be to limit increases

in short-term rates, rather than causing

benchmark or other medium- to long-term

rates to fall.

Owing to the recent trend of foreigners

selling KTB futures, the trading range of

benchmark rates has shifted upward, but con-

sidering the pent-up demand within the bond

markets and the fact that accumulated for-

eigner-held positions are near historical

highs, such selling is unlikely to have a sig-

nificant impact on market yields.

37

Market Watcher

Exchange Rate: As uncertainties dissipate, a gradual strengthening of the

KRW is expected

Yootag Jung, Associate Researcher

[Figure 1] The KRW Strengthened as a Result of

Improved Domestic and External Conditions

[Figure 2] Liquidity Conditions in Europe's

Banking Sector Improved

1000

1050

1100

1150

1200

1250

11.7 11.9 11.11 12.1 12.310

20

30

40

50

60

KRW/USD (L) VIX (R)

(KRW) (Index)

0

20

40

60

80

100

120

11.7 11 .9 11.11 12.1 12 .3

-180

-150

-120

-90

-60

-30

0

Euro OIS Spread (L)

Euro Basis Swap (R)

(bp) (bp)LTRO 1 LTRO 2

Source: Bloomberg Source: Bloomberg

As the year opened, the USD/KRW ex-

change rate was hovering around 1,140-1,160

won, but then fell to the 1,100-1,120 range

after S&P's downgrade of the Eurozone in

mid-January, which actually helped clear

some of the uncertainty, as well as the Fed's

announcement that it would maintain

near-zero interest rates for an extended

period. The second round of LTRO, the sec-

ond round of Greek aid, and growing ex-

pectations for a US recovery helped to main-

tain the basic trend, although further down-

ward movement was limited by the ongoing

Greek crisis, fears of a global economic

slowdown, and rising oil prices. As a result,

the USD/KRW exchange rate has been hov-

ering within a 1,110-1,140 won range.

In particular, the second round of the

ECB's highly-anticipated LTRO program was

larger than expected (€529.5 billion), and

like the first round, created enough liquidity

to help ease credit market conditions and

stabilize Europe's sovereign bond markets,

while also easing concerns about the health

of the financial sector as short-term funding

costs declined. In addition, the voluntary par-

ticipation rate of private sector creditors in

Greece's debt swap was 85.8%. This further

helped to mitigate fears about debt delever-

aging or a disorderly default in the

Eurozone, thereby signalling that any imme-

diate, adverse impacts of the European crisis

on global financial markets are beginning to

wane.

38


[Figure 3] China's Exports Slowed While Its

Trade Deficit Expanded

[Figure 4] Tensions in Iran Fueled Oil Price

Volatility

-40

-30

-20

-10

0

10

20

30

40

50

60

11.1 11.3 11.5 11.7 11.9 11.11 12.1-40

-30

-20

-10

0

10

20

30

40

50

60

Trade Balance (L)Exports (R)Imports (R)

(bil.$) (YoY, %)

70

80

90

100

110

120

130

11.1 11.3 11.5 11.7 11.9 11.11 12.1 12.3

Dubai WTI

(USD/Barrel) NDA Act

Source: Bloomberg Source: Bloomberg

With the strains in Europe beginning to

ease, the exchange rate will likely be de-

termined mostly by the direction of the real

economy in major economies. In the US, 4Q

2011 GDP was recently revised upward from

2.8% to 3.0% and employment continues to

improve, but doubts remain about the sus-

tainability of the recovery. In Europe, the

economic downturn is accelerating, with cri-

sis-ridden countries posting two consecutive

quarters of negative growth. Even emerging

economies appear to be officially slowing. In

China, for instance, February production and

consumption numbers came in below expect-

ations, and the trade deficit soared to $31.5

billion, its highest level in 20 years, fueling

fears that the world's second-largest economy

could be headed for a severe slowdown. On

top of these fears, the standoff in Iran has

pushed up oil price volatility, adding fuel to

fears of a global economic slowdown.

Over the short term, the downtrend in the

USD/KRW exchange rate is likely to con-

tinue, particularly as the crisis in Europe sta-

bilizes on the back of the new Fiscal

Stability Treaty, waning Greek concerns, and

improved liquidity conditions. The Korean

government's clarification of its monetary

stance, as well as improvements in the trade

surplus, should also strengthen the KRW.

However, other factors could exert upward

pressure on the exchange rate, including

whether European banks raise adequate capi-

tal by the June deadline, the determination

by ISDA that Greece's debt swap was indeed

a credit event, an economic downturn in

Europe and emerging economies, and volatile

oil prices. Even if such events cause the ex-

change rate to rise temporarily, however, the

general trend should be downward, poten-

tially falling below 1,100 won some time

over the next quarter.

39

Market Watcher

Equities: A weak start in 2Q should pave the way to a stronger finish

Yonghyun Cho, Strategist, Hana Daetoo Securities

[Figure 1] Net Foreign Purchases of Korean

Equities

[Figure 2] Correlation Between Equity and Oil

Prices (2008 to Present)

-8

-6

-4

-2

0

2

4

6

8

09.1 09.7 10.1 10.7 11.1 11.7 12.1

(\tn) 6.9

4.3y = 0.0965x - 32.538

R2 = 0.7304

20

40

60

80

100

120

140

160

600 800 1000 1200 1400 1600 1800

(Oil Price ,$)

Global Equity Index

Reverse correlation above $120

Source: KRX, Hana Daetoo Securities

Source: Thomson Reuters, Hana Daetoo Securities

Note: Oil price is average of Brent, Dubai and WTI

Korea's equity market has been in an

uptrend since the start of 2012 － something

of a surprise to many, since the consensus

outlook at the end of last year expected the

market to suffer a correction and elevated

volatility sometime in 1Q, followed by a

gradual recovery through the rest of the

year.

The consensus forecast expected elevated

volatility in 1Q based on a number of fac-

tors, such as the potential S&P downgrade

of the Eurozone in January, as well as the

maturity schedule of PIIGS sovereign bonds.

These events had limited impact, however, as

S&P's downgrade of the Eurozone had appa-

rently already been priced in, while the debt

of the PIIGs was rolled over through the

ECB's LTRO operations.

US economic indicators, which had begun

to turn upward last October, continued to

improve into the new year. This positive

trend － combined with global policy support

in the form of the ECB's LTRO operations,

further quantitative easing by the BOJ, eased

reserve requirements by the PBC, as well as

hopes for QE3 by the Fed － helped the

global liquidity situation to improve rapidly,

providing a boost to global equity markets.

As the global liquidity environment im-

proved, massive foreign capital flows found

their way into Korea's equity markets. In

January, net inflows were ₩6.9 trillion, the

highest ever recorded over a monthly period,

40


[Figure 3] S&P500 Index vs. EPS [Figure 4] Forward EPS Growth & P/E Ratios

0

200

400

600

800

1000

1200

1400

1600

2008 2009 2010 2011 2012$0

$5

$10

$15

$20

$25

$30Quarterly EPS (R)

S&P500 (L)

(Index)

KoreaUK

FranceGermany

TaiwanSingaporeIndia

China

Indonesia

ThailandUS

Canada

Brazil

6

7

8

9

10

11

12

13

14

15

16

0 5 10 15 20 25

(P/E)

(EPS Growth)

Source: S&P, Hana Daetoo Securities Source: Bloomberg, Hana Daetsoo Securities

and foreign capital continued to flow into

Korea's markets in February as well. January

also saw the KOSPI rise above 2000 for the

first time in six months.

Any one of the following three main fac-

tors could influence the general direction of

the equity markets in 2Q. First is the geo-

political risk and oil price volatility stem-

ming from the Iranian nuclear issue. Second

is the political risk stemming from Greek's

parliamentary elections and France's presi-

dential elections. And third is the direction

of the economy and corporate earnings.

With regard to the first factor, oil price

volatility is likely to continue until tensions

in the Strait of Hormuz are resolved. This is

likely to have a negative impact not only on

already-high inflation but on equity markets

as well. As for the second factor, there re-

mains some possibility that the results of

key national elections in Europe could have

a negative influence on ongoing intra-region-

al efforts to resolve European fiscal woes.

As for the third factor, it seems likely

that the global economy and corporate earn-

ings will recover slowly in 2Q after bottom-

ing in 1Q, as previously sluggish employ-

ment and construction in the US continue to

recover, and as China's efforts to reverse

previous tightening and stimulate domestic

demand help to buffer the slowdown in its

economy.

Korea's equity market should start off

weak in 2Q but regain strength in the latter

part. After the strong rise in 1Q, not only is

a technical correction warranted, but geo-

political and political risks could also have a

negative impact. But as economic momentum

and corporate earnings are expected to recov-

er after 1Q, the equity market will also like-

ly be able to get back on the path to recov-

ery following a brief correction.

Documents

Hana Insight (Hana Institute of Finance)_Issue#3