Bank stocks in South Korea have long been regarded as an unappealing option for investors. Against this backdrop, a local activist fund was launched Monday targeting seven large Korean lenders to whet investor appetite by shoring up dividends.
Korean banks have strong fundamentals and enough capital to cushion against unexpected losses, but their dividend payout ratios remain much lower than those of their global peers, according to Lee Chang-hwan, CEO of Seoul-based private equity firm Align Partners.
“The cause of the deep undervaluation of Korean banks lies in inefficient capital allocation, in which most of the capital capacity has been funneled into reinvestment without a shareholder value perspective,” he said during the launch of his firm’s activist campaign against bank stocks on Monday.
Undervaluation of bank stocks here is nothing new. Local lenders tend to adjust the amount of loans in accordance with government regulations, build up provisions in preparation for crises, and keep their dividend payouts low, prompting stocks to remain at low price levels for a long time.
He called on local financial holding companies to alter capital allocation policies to lower provisions that they hold against losses incurred in their loans. Instead, the activist fund demanded that lenders increase shareholder returns -- the ratio of the total amount of dividends paid out to shareholders and share buybacks relative to the net income of the company -- to 50 percent.
According to Lee, the average rate of shareholder returns of domestic bank stocks was 24 percent in 2021, compared to 64 percent of 10 foreign banks including Singapore’s United Overseas Bank, Taiwan Cooperative Financial Holding, the Bank of America and Citibank.
“Excessive risk-weighted asset growth must be controlled to a reasonable level in order to raise cash for capital expansion and shareholder return, just like overseas banks,” Lee said.
In the long run, if their stock undervaluation issues are resolved, banks' ability to raise external capital will be strengthened, and lead to national wealth creation as the National Pension Service holds an average 8 percent of stake in the bank stocks, he added.
The shareholder campaign is lodged against seven banking groups -- KB Financial Group, Shinhan Financial Group, Hana Financial Group, Woori Financial Group, JB Financial Group, BNK Financial Group and DGB Financial Group.
Recently, there have been some moves toward improvement of shareholder values in the financial industry.
On Jan. 4, Shinhan Financial Group Chief Financial Officer Lee Tae-kyung vowed to return the full amount to shareholders for total capital ratio exceeding 12 percent. It was the most aggressive move among the shareholder return plans announced by local financial holding companies so far.
"The main reason that (Shinhan stock’s) price-to-book ratio remains low is the lack of shareholder return," he said. “We will maintain a capital ratio of 12 percent and return to shareholders for the portion exceeding this level.”
The ratio, a barometer of financial soundness, measures the proportion of a bank's capital to risk-weighted assets. Banks are required to maintain the ratio above 10.5 percent.
Following the announcement, shares of Shinhan Financial Group surged 16.8 percent as of Tuesday.
Finance regulators and think tanks also suggested that implementation of shareholder-friendly policies as a solution for “the Korea discount,” which refers to the persistently low valuation of Korean stocks induced by factors like the North Korea threat and weak corporate governance.
“We will minimize the involvement of financial authorities in the autonomous decision-making of the financial sector, such as dividends by banks and financial holding companies,” Financial Supervisory Service Gov. Lee Bok-hyun said in November.
But a big jump in dividends in a short period of time is unlikely.
Profits have increased in the face of interest rate hikes last year, but concerns about a decline in interest income this year are growing as the rate of loan growth slows.
With the global economy continuing to face multiple macroeconomic headwinds this year, banks also need to prepare for crisis management by measures to support small business owners and customers with account delinquency.
“It seems difficult right now to radically raise shareholder return with only an arithmetic approach,” an official at a banking group said on condition of anonymity.
Align Partners requested the seven banking groups to introduce a new capital allocation policy and a mid-term shareholder return policy through a board resolution by Feb. 9. It also requested the banks to make an official announcement through a public disclosure.