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8/3/2019 Fledgling Hedge Fund Market Will Need Time to Gain Momentum
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www.wooriwm.com
Fledgling hedge fund market will need time togain momentum
2012 outlook: Share price fluctuations driven by short-term momentum
We initiate coverage on the securities sector with a Neutral recommendation.
While both a likely higher portion of individual financial assets and thedomestic introduction of hedge funds (which should expand investmentopportunities for securities firms) bode well for the securities sector, tangibleearnings momentum from these changes will likely need some time to develop.
Rights offering-related ROE dilution effect > revenue from new sources
The hedge fund market should grow to around the W30tn-level by 2014,generating around W200bn pa worth of additional income for the sector.
But, the fledgling hedge fund market is unlikely to see strong expansion duringits early development phase as obstacles lie in its path, including the absence ofan established track record and a shortage of experienced professionals.
In FY2012 (fiscal year ends in March), the combined net profit of the foursecurities players under our coverage should rise by 21.5% y-y; however, giventwo announced rights offerings, meaningful ROE improvement looks unlikely(FY2010: 10.4% FY2011E: 8.9% FY2012F: 9.4%).
Top pick: Kiwoom Securities; Samsung Securities also deserves attention
We initiate our coverage at Buy, suggesting a target price of W75,000.
Our key investment points for Kiwoom Securities are as follows: 1) itssustained outstanding growth in the brokerage business; 2) its leading status inthe mobile trading system (MTS) market; 3) its likely expanded lendingcapacity (brokers loans) upon the planned acquisition of a savings bank; and 4)the likelihood that it will be a primary beneficiary of the introduction of an
alternative trading system (ATS; currently under discussion). Also warranting attention in our view is Samsung Securities (Buy, target price
of W65,000). As the largest wealth management securities company in Korea,Samsung Securities will likely enjoy a rising premium in line with a likelyincreased portion of individual financial assets. Moreover, the company isexpected to be the frontrunner in hedge fund product sales.
Securities IndustryIndustry Analysis
Nov 25, 2011
Securities sector investment recommendation/investment indicators (Units: won, %, x)
OP margin P/E P/B ROECode Rating TP (12M)
Currentprice 2011E 2012F 2011E 2012F 2011E 2012F 2011E 2012F
Samsung Securities (016360.KS) Buy( Initiate) 65,000( Initiate) 50,000 12.6 12.4 12.6 12.7 1.1 1.0 8.8 8.3Daewoo Securities (006800.KS) Hold(Initiate) 12,000(Initiate) 10,100 6.0 8.8 14.1 12.0 0.9 0.8 5.3 6.7Mirae Asset Securities (037620.KS) Buy(Initiate) 43,000(Initiate) 32,100 8.8 9.8 9.8 8.1 0.7 0.6 7.1 8.1
Kiwoom Securities (039490.KS) Buy(Initiate) 75,000(Initiate) 55,500 30.8 34.6 11.5 10.0 1.6 1.4 14.5 14.5Note: Based on Nov 18 closing pricesSource: Woori I&S Research Center estimates
Neutral (Initiate)
Analyst
Dahee Woo822)768-7137, [email protected]
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CONTENTSI. Summary .............................................................................................................................
II. Capital movement to stock market has begun...........................................................
1. Waning property investment boom
2. Financial assets likely to expand
III. ROE at standstill ................................................................................................................
1. Korean securities industry finding it difficult to sustain on agency-oriented
profit structure
2. Hedge fund launch to boost income over mid- to long term
3. Dilution of ROE from rights offering > revenue from new resources
IV. Share price momentum positive over longer term; but soft in near term..........
1. Valuations nearing historic low; unlikely to rise over near term
2. Investment strategy: Suggest range-bound trading based on short-term
momentum; over long term, suggest buying shares below P/B of 0.7x
[Company Analysis]
Samsung Securities [Buy, TP W65,000] .........................................................................
Daewoo Securit ies [Hold, TP W12,000] ........................................................................
Mirae Asset Securities [Buy, TP W43,000] .....................................................................
Kiwoom Securities [Buy, TP W75,000] ............................................................................
3
4
9
27
32
36
40
44
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Securities Industry www.wooriwm.com
I. Summary
2011 securities
industry review:
Largestunderperformer
among financial
sectors; lags 2011
Kospi by 33.8%p
(YTD)
Thus far in 2011, the securities sector has lagged the Kospi by 33.8%p YTD, posting the
lowest returns among financial sectors (banking: 18.3%p underperformance; insurance:
3.8%p outperformance). We attribute this underperformance to: 1) rising market concernsover a lack of new revenue sources; 2) large-scale rights offerings at large securities firms
aimed at raising capital for their prime brokerage services (PBS); and 3) government
regulatory risks (ie, ban on short-term loans). Presently, the securities sector trades at a P/B of
0.74x (vs 0.8x during the 2008 financial crisis). In terms of valuation, we view the securities
sector as being significantly more attractive than other financial sectors. Despite concerns
over the securities sectors growth potential, we believe it is unlikely that sector will turn to
loss again like in 2004, noting that sector fundamentals have considerably strengthened since
that time.
As such, we view as meaningful the question of whether the sector will be able to repeat a
gradual uptrend going forward, similar to that which was witnessed in 1999, 2005, and 2007.
Positive changes
expected in 2012;meaningful ROE
improvement
unlikely
From a macro-economic perspective, there have been some positive changes for the securities
sector. Given that Koreas baby boom generation is closing in on retirement age, the portionof individual financial assets is expected to expand going forward. We draw attention to the
fact that government policies toward the securities sector have recently turned favorable,
including deregulation of the net capital ratio (NCR) criteria in order to expand investment
opportunities for securities players.
However, it will likely take some time for these positive changes to translate into meaningful
earnings growth for the securities sector. Over the short term, we believe concerns over ROE
dilution caused by large-scale rights offering by some large securities firms will outweigh
expectations for potential mid- to long-term growth momentum.
The hedge fund market should grow to around the W30tn-level by 2014, generating around
W200bn pa worth of additional income for the sector (assuming that around 10% of capital
presently invested in risky assets moves to hedge funds). However, it is our opinion that the
fledgling hedge fund market is unlikely to see strong expansion during its early developmentphase as several obstacles need to first be overcome, including the absence of an established
track record and a shortage of experienced professionals.
Securities shares to
fluctuate driven by
short-term
momentum
In consideration of the above-listed factors, we believe thateven at the current low (and
thus very attractive) valuation levelsecurities shares are unlikely to show a steady rise in
the near future. We believe that the securities sector shares will only start outpacing the Kospi
again once meaningful ROE improvement is established. While we estimate that the
combined FY2012 net profit of the four securities firms under Woori I&Ss coverage will rise
by 21.5% y-y;, these players are unlikelyin consideration of rights offeringsto show ROE
improvement to a degree that would be sufficient to push up share prices (Average ROE:
FY2010 10.4% FY2011E 8.9% FY2012F 9.4%).
In addition, if the governments proposed measures to protect investors (including hikes incustomer deposit usage fees) were to be actually implemented, the regulations would likely
hurt securities firms earnings, as well. Accordingly, for 2012, we believe that securities
shares will fluctuate, mainly driven by short-term momentum.
Top pick: Kiwoom
Securities
Samsung Securities
also deserves
attention
We present Kiwoom Securities as a top pick for the securities sector, citing the following
key investment points: 1) its sustained outstanding growth in the brokerage business; 2) its
leading status in the MTS market; 3) its likely expanded lending capacity (brokers loans)
upon the planned acquisition of a savings bank; and 4) the likelihood that it will be a primary
beneficiary of the introduction of an ATS (currently under discussion).
Also warranting attention in our view is Samsung Securities. As the largest wealth
management securities company in Korea, Samsung Securities should enjoy a rising premium
in line with a likely increased portion of individual financial assets. Moreover, the company is
expected to be the frontrunner in hedge fund product sales.
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II. Capital movement to stock market has begun
1. Waning property investment boom
Portion of real assets
(property) out of
Koreas household
assets is much higher
than that in other
countries
As property prices have risen steadily over a long period of time in Korea, it has become
conventional wisdom for households to buy property if possible. In particular, drastic
property price increases were have been seen since the millennium, at about which time many
Korean baby boomers (generation born between 1955 and 1963; account for 14.6% of
Koreas total population) gained the means to purchase property. As a result, baby boomers
have driven up housing demand. Moreover, as baby boomers have shown a strong preference
for property as their first choice of investment vehicle, property holdings now account for
74.8% of Korean baby boomers combined total assets. In contrast, financial assets account
for a mere 22.2% of total assets (vs 45% in Japan and 63% in the US), suggesting an
excessive concentration of property in asset portfolios.
Japan and US:Demographic
changes have
resulted in housing
market recession
In the US and Japan, housing prices have displayed a mid- to long term decline since the startof a contraction in the size of the population segment aged 35~54. Given this pattern, it can
be seen that a reduction in the economically-active population generally tends to result in
lowered housing demand.
In Japan, housing prices have been plunging sharply since 1990, likely in response to the
slowing growth of economically-active population coinciding with the governments property
market cooling policies (including large-scale rate hikes). At present, despite the
governments stimulus efforts, Japans housing prices have continued to fall due to declines in
both household income and real housing demand.
In the US, housing prices have been sliding since 2006this drop is partly attributed to baby
boomer (78mn people born in 1946-1964) retirements and a decrease in the size of the
population aged 35-54.
Japan: Housing prices dropping since 1990 in line withreduction in economically-active population
US: Housing prices declining since 2006 in conjunction withretirement of baby boomers
0
50
10 0
15 0
20 0
25 0
30 0
35 0
'70 '75 '80 '85 '90 '95 '00 '05
24
2628
30
32
34
36
38
40Population aged 35-5 4 (RHS)
Housing price index (LHS)
('10.3=100) (Mn ppl)
60
10 0
14 0
18 0
22 0
26 0
'00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10
81
82
83
84
85
86
87
88Population aged 35 -54 (RHS)
Housing price index (L HS)
('00.1=100) (Mn ppl)
Note: Housing price index based on nationwideSource: Statistics Bureau of Japan, Bloomberg
Note: Housing price index based on big-10 citiesSource: US Census Bureau, Case-Shiller
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Securities Industry www.wooriwm.com
Property prices to
keep falling following
retirement of baby
boomers
Since 2010, Koreas baby boomers (as noted earlier, the approximately 7.12mn people born
between 1955~1963), have begun to retire. Moreover, the nations economically-active
population (ages 35~54) is expected to peak out this year. Based on the already discussed
patterns in the Japan and the US, we believe domestic property prices will keep falling after
baby boomers retire, noting: 1) effective demand for housing should slow due to babyboomers retirements and the relatively low estimated average income level of potential
homebuyers; and 2) given likely lower income for 10 years after retirement (of note, the
average retirement age for company employees in Korea is 50~55) until pensionable age
(ages of 60-65), baby boomers are likely to dispose of property investments.
Baby boomers likely
to sell properties
after retirement
Compared to their counterparts in Japan and the US, Korean baby boomers assets are greatly
concentrated on property holdings; moreover, elderly Koreans tend to depend greatly on their
children for income. Given that the pension system in Korea is still less developed than in
other nations, the income of Koreans tends to fall sharply after retirement. Meanwhile, 75%
of baby boomers own a house, with 70% of these homeowners being leveraged, indicating
weak financial health.
For Koreans aged 50-60 (a segment which includes most of the baby boomers), financialliabilities are equal to 87% of their household income (or 114.4% of disposable income);
furthermore, their debt repayment burden is likely to increase following retirement. Thus, we
believe a large portion of the population in such circumstances will decide to sell property in
order to secure financial assets. Given declining real housing demand and reduced property
holdings, we project that domestic property prices will steadily decline in line with the
reduction in the size of the economically-active population.
Korean property prices to fall on expected decrease in economically-active population from 2011
20
30
40
50
60
70
80
90
100110
'86 '91 '96 '01 '06 '11E '16F '21F '26F
8
9
10
11
12
13
14
15
1617
Population aged 35-54 (RHS)
Housing transaction price index (LHS)
('11.6=100) (mn persons)
Source: Statistics Korea, KB
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Assets of baby boomers; sources of income for population aged 60 and above
Korea Japan US
Financial assets per capita W73mn JPY18.68mn US$860,000
% of total assets Properties 74.8%Financial assets
45%Financial assets
63%
Public pension 6.6% 57.4% 55.8%
Support from children 56.6% 6.6% 1.6%
Job income 26.6% 21.6% 15.5%
Source of income forthose aged 60 andabove
Assets 9.9% 6.6% 23.3%
Source: Statistics Korea, KIHASA
Debt to income (financial liability to household income), by age group (Units: W10,000, %)
Disposableincome (A)
Ordinaryincome (B)
Financialliability (C)
DTI(C/A) DTI(C/B)
~30 2,176 2,706 856 39.3 31.6
30~40 3,252 4,183 2,890 88.9 69.140~50 3,661 4,777 3,807 104.0 79.7
50~60 3,533 4,647 4,042 114.4 87.0
60~ 1,681 2,133 1,577 93.8 73.9
Source: Statistics Korea
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2. Financial assets likely to expand
US: 1985~2007 stock
market expanded on
low interest-rateenvironment
In the US, shares have risen sharply since 1985, a time during which high-earning and high-
spending baby boomers have been reaching middle age. In keeping, stocks have been
accounting for a greater portion of US household financial assets since the mid- to late 1990s.In fact, the Dow Jones Industrial Average grew a towering 930% over 1985~2007, catalyzed
by steady falls in interest rates.
Japan: Aging society
sparked surge in
financial assets
Meanwhile, the Japanese stock market rallied between the early-1980s and 1990, at which
time Japans first baby boom generation (born in 1930~1939) was well into middle age and
its second baby boom generation (1947-1979) was starting to reach middle age. While the
Japanese stock market has trended downward since peaking in the 1990s, the portion of
personal financial assets continued to rise at a CAGR of 4% from the 1980s to the 2000s
(1984: JPY556tn 2009: JPY1,485tn). In particular, safe assets (including insurance,
pensions, cash, and savings) increased markedly, as baby boomers prepared for retirement.
Lower real interest rate in USbullish stock marketJapanese stock market saw rise starting in 1985 on greaterdemand from baby boomers
-6.0-4.0
-2.0
0.0
2.0
4.0
6.0
8.0
10.0
12.0
'70.1 '75.1 '80.1 '85.1 '90.1 '95.1 '00.1 '05.1 '10.1
02,000
4,000
6,000
8,000
10,000
12,000
14,000
16,000
10yr treasury yield-CPI y-y (LHS)
DJIA (RHS)
(%) (P)
05,000
10,000
15,000
20,000
25,000
30,000
35,000
40,000
45,000
'70.2 '75.2 '80.2 '85.2 '90.2 '95.2 '00.2 '05.2 '10.2
Nikkei 225 Index
(P)
Source: Bloomberg Source: BOJ, Statistics Bureau of Japan, Datastream
Japan: Personal financial assets increasing in line withaging population
Aging population and insurance/pension closely correlated
0
20 0
40 0
60 0
80 0
1,000
1,2001,400
1,600
1,800
'84 '86 '88 '90 '92 '94 '96 '98 '00 '02 '04 '06 '08
Cash/deposit Stock
Insu rance /pension Investmen t trust
Others
(JPYtn)
5
10
15
20
25
30
35
'85 '90 '95 '00 '05 '07 '08 '09
5
10
15
20
25
% of insurance and pension (LHS)
% of population aged 65 and above (RHS)
(%) (%)
Source: BOJ, Statistics Bureau of Japan, Datastream Source: BOJ, Statistics Bureau of Japan, Datastream
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Aging of population
tends to result in
asset portfolio
changes
Socioeconomic patterns in the modern history of the US and Japan have displayed the
following common features: 1) property prices have dropped in the wake of demographic
changes; 2) stock markets became bullish after baby boomers entered the middle age and
elderly age groups; 3) the portion of individual financial assets increased following the
retirement of baby boomers; and 4) among the elderly segments of the population, demandfor safe assets (including insurance and pensions) has outstripped that for risky assets. In the
following analysis, we will identify where Korea now stands in terms of these interrelated
demographic and economic patterns.
Money moving
towards financial
assets: Risky assets
have taken greater
portion since 2005
Risky assets have taken a greater portion of total financial assets in Korea since 2005, as: 1)
stock demand increased after baby boomers reached the middle or elderly age segments (key
income and spending groups); and 2) interest rates have been low during this period. Despite
population aging, we believe that the portion of risky assets will increase steadily in Korea in
the near term, in line with baby boomers accumulation of financial assets. However, once
Korea turns into a super-aged society (as Japan did in 2006), demand for safe assets
(including insurance and pensions) should outstrip demand for risky assets, due to the elderly
populations general aversion to risk. Of note, Korea is now considered to be an aging
societyit is expected to become an aged society in 2018 and a super-aged society in 2026.
However, when considering both the higher portion of real assets (vs that in other countries)
and increasing asset size upon higher gross national income (GNI), we believe that (assuming
that capital continues to flow into the financial market) the chances are slim that the absolute
amount of risky assets (eg, equities) will decline within the foreseeable future.
Portion of ri sky assets is increasingAnnual comparison of countries that have enteredaging/aged/super-aged society demographic categories
7%(aging society)
14%(aged society)
20%(super-aged
society)
Korea 2000 2018 2026
Japan 1970 1994 2006
US 1942 2015 2036
52 49 47 46 42 46 44 44 44
22 2322 23 23
25 24 24 25
4 56 7 10
7 7 5 4
15 15 19 18 20 15 17 18 19
7 7 6 6 5 7 8 8 8
0%
20%
40%
60%
80%
100%
'03 '04 '05 '06 '07 '08 '09 '10 1Q11
Deposit Insurance & annuity BC Equity Others
Source: Bank of Japan, Statistics Bureau of Japan
Source: Bank of Japan, Statistics Bureau of Japan
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III. ROE at standstill
1. Korean securities industry finding it diff icult to sustain on agency-
oriented profit structure
Disparity between
securities sector and
Kospi wider than in
past
Compared to the Kospi, the securities industrys share price momentum has weakened over
the past two years. In terms of absolute performance, the Kospi (as of Oct 2011) has risen
20.8% versus two years ago, while the securities sector has slid 26.6% over the same time
period. Given that the formerly widely-held domestic investor maxim that a buy signal for
securities stocks equals an uptrend for the Kospi no longer holds true, we point out that the
correlation between the Kospi and the securities sector has weakened over the past two years.
Despite Kospis rally,
securities sectors
P/B premium
decreasing
Due to this widening disparity between the Kospi and the securities sector, the basis for
applying a premium to securities stocks has changed. Prior to 2009 (when the Kospi
displayed an upward trajectory), the P/B-based value of securities shares traded at a premium.
During that time period, the level of premium varied depending on the Kospis trading range,but the securities sector was closely correlated with the Kospi overall.
However, the post-2009 P/B-based value of securities shares has been seen to actually
decrease during Kospi uptrends.
Despite Kospis upward trajectory, securities sector at standstill
0
500
1,000
1,500
2,000
2,500
'05 .3 ' 05 .9 ' 06 .3 ' 06 .9 ' 07 .3 ' 07 .9 ' 08 .3 ' 08 .9 ' 09 .3 ' 09 .9 ' 10 .3 ' 10 .9 ' 11 .3 ' 11 .9
0
1,000
2,000
3,000
4,000
5,000Kospi (LHS)
Securities sector index (RHS)
(P) (P)
Source: Dataguide Pro
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Securities Industry www.wooriwm.com
Correlation between Kospi and premium on securities sector has weakened
P/B-based valuation: Prior to Jun2009, premium was applied to
securities shares during Kospi rises
Source: Dataguide Pro
500
1,000
1,500
2,000
2,500
'05 .3 ' 05 .9 ' 06 .3 ' 06 .9 ' 07 .3 ' 07 .9 ' 08 .3 ' 08 .9 ' 09 .3 ' 09 .9 ' 10 .3 ' 10 .9 ' 11 .3 ' 11 .9
0.4
0.6
0.8
1.0
1.2
1.4
Kospi (LHS)
Securities sector's P/B/Kospi' s P/B (RHS)
(P) (x )
500
1,000
1,500
2,000
2,500
'05 .3 ' 05 .9 ' 06 .3 ' 06 .9 ' 07 .3 ' 07 .9 ' 08 .3 ' 08 .9 ' 09 .3 ' 09 .9 ' 10 .3 ' 10 .9 ' 11 .3 ' 11 .9
0.4
0.6
0.8
1.0
1.2
1.4
Kospi (LHS)
Securities sector's P/B/Kospi' s P/B (RHS)
(P) (x )
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Uncertainty exists
over securities firms
profit-generating
ability
Likely due to uncertainty over its profit-generating ability stemming from a perceived lack of
growth potential, the securities sector has been performing sluggishly over the past two years.
Despite the Kospis upward trend in 2010, securities shares have not traded at a premium,
likely due to a decline in commissions (which represent an important source of revenue for
securities firms) stemming from fiercer competition in the brokerage market.In light of ongoing downward pressure on securities firms ROE due to a weakening in their
business models, uncertainties have emerged involving the ability of sector players to
generate significant profit (vs book value).
Key to growth is to
secure new revenue
sources
Given this situation, we believe thatin order for their shares to trade at a higher premium to
the marketsecurities firms need both to ease the above-discussed worries over their profit-
generating ability and to secure new sources of revenue.
In the case of the USwhere the ceiling on brokerage commissions was lifted in May
1975securities firms have widened their business scope to include asset management (wrap
accounts) or institutional client services (PBS), both of which have significantly contributed
to sector earningsbased on 2010 sales, Goldman Sachs institutional client services
accounts for 55.7% of net operating income, while Merrill Lynchs asset management,
distribution & administration represents 25.2% of net operating income. By meeting clients
growing needs for retirement planning amidst a low-interest rate environment, this
diversification of revenue sources has enabled US securities firms to realize positive growth.
Looking at domestic securities firms, despite changes within the financial market
environment, commission income still accounts for a large portion (64%) out of net operating
revenue as sector players have experienced difficult in diversifying their revenue streams.
Morgan Stanleys diversified profit structureKorean securities industrys profit structure: Agencyaccounts for more than 60%
Principal
transcation
35%
Others5%
Net interestincome
3%
Asset
management,
distribution
and
adimistration
fees
Commision
16%
Investment
banking
16%
Interest
income
33%
Wealth
management
11%
Investment
banking
8%
Brokerage
41%
Others6%
Net trading
income
1%
Note: Based on 2010 salesSource: Morgan Stanley
Note: Portion based on net operating income. Others category includes valuationand disposal gains on loans and foreign exchange transaction gains.
Source: Financial Statistics Information System (FSIS)
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Potential new
revenue sources: IB
or wealth
management
When considering both the low-interest rate environment and the aging of the domestic
population, wealth management services and investment banking services are viewed as
representing new revenue sources for Korean securities firms. Domestic firms have now
started to offer wealth management services, introducing various products aimed at the
specialized needs of clients. In addition, upon the scheduled introduction of hedge funds,domestic securities firms should be enabled to broaden their business scope from traditional
areas (eg, M&A, brokerage, IPO acquisitions) to new business domains (eg, PI, PBS).
Wealth management (WM): Domestic firms have begun to offer wealth management
services for high-net-worth (HNW) clients interested in shifting their focus from realizing
high returns over a short period toward realizing steady returns within the current low-
interest rate environment.
Investment banking (IB): In order to further develop the domestic capital market, the
Korean government is looking to introduce hedge funds. Hedge fund licensing is scheduled
to begin in Dec 2011 for securities firms (Daewoo Securities, Samsung Securities, Woori
Investment & Securities, Korea Investment & Securities, and Hyundai Securities) which
have met the governments criteria (minimum capital requirement of W3tn).
Profitability of securities industry over 2000~2010
Need to secure new revenue sourcesNeed to secure new revenue sources
Despite efforts for revenue diversification, brokerage portion still highDifficult to improve profitability of PI and WM
Profitability worsening from heated competition
Profitability has weakened over past five yearsProfitability has weakened over past five years
ROE: FY05 20% FY10 7.5%
Shareholders equity 97% , NP 21%
Decreased brokerage commissionDecreased brokerage commission
Daily average trading value: W5.6tn (FY05) W7.9tn (FY10)
Commission continues to fall due to intensifying competition (16bp 11bp)
Falling contribut ion of brokerage units; revenue diversification effortsFalling contribution of brokerage units; revenue diversification efforts
Brokerage po rtion from 71.4% in FY05 to 37.9% in FY10Net interest income increase from rise in brokers loans
Slight increase in contribution of IB and WM
Source: Woori I&S Research Center
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2. Hedge fund launch to boost income over mid- to long term
Hedge fund launch
scheduled for Dec
2011
Following the revision of Capital Market Act on Sep 27, the domestic launch of hedge funds
is slated for Dec 2011. The introduction these funds should allow Koreas securities firms to
diversify their business scope beyond existing brokerage services.As hedge funds seek returns regardless of market conditions, a wide range of management
strategies are possible. We believe hedge funds various investment strategies will contribute
to the growth of Koreas capital market both by offering a broader array of investment
opportunities and by injecting greater liquidity. However, in order not to repeat the mistakes
of US hedge funds (remembering the collapse of prime broker Lehman Brothers and the
subsequent global financial crisis), the government will place limits on Koreas new hedge
fund market, including both a leverage ceiling (up to 400%) and the compulsory reporting of
transaction records.
Hedge fund related business
Source: Woori I&S Research Center
Asset mgtcompanies
Invest (deposit)
Investor
Securities firms
Hedge fund
operation
Order assetmanagement
Prime brokerage
service
Stock lendingStock lending
Brokers loanBrokers loan
Trade executionTrade execution
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Rapid growth of
hedge fund unlikely
in initial stages
We positively view the upcoming introduction of hedge funds, believing the launch will lead
to growth for Koreas capital market over the mid- to long term. However, as the fledgling
hedge fund market will need some time to gain growth momentum, the positive impact of this
new business on sector players will likely be limited over the short term.
The fledgling hedge fund market is unlikely to see strong expansion during its earlydevelopment phase as several obstacles will need to be overcome the following investor
concerns: 1) the lofty minimum investment ceiling (W500mn); 2) the lack of an established
track record; and 3) the typically conservative stance of pension funds. Meanwhile, we
consider the risks from the suppliers perspective as being a lack of skilled, experienced
professionals and the governments restrictions (including a leverage ceiling) on possible
asset management strategies.
1) High entry barrier
for investors
Hedge fund investors will likely largely be divided into: 1) retail investors; and 2)
institutional investors (including pension funds). Of note, the hedge fund market has been
expanding rapidly and globally since the 1990s. In the initial launch stages of the industry,
retail investors represented around 60% of clients; however, the retail investor portion has
now dropped to the 20%-range in the wake of an influx of institutional investors.
Noting the lofty minimum investment ceiling (W500mn), we believe the Korean hedge fund
market will be driven by institutional investors rather than retail investors
We assume that retail investors capable of investing W500mn in hedge funds will possess
financial assets worth at least W2.5-3.0bn. Of note, as of end-2010, the segment of the
Korean population possessing financial assets of over W1.0bn had reached 130,000 (with per
capita financial assets within this segment standing at W2.2bn). Drawing attention to a survey
on wealth management tools showed investment in financial assets ranking second (following
property) among preferred vehicles, we expect capital inflow into financial products to
increase over the mid- to long term. Nonetheless, over the near term, retail investors are
unlikely to switch to risky hedge funds with no proven track record when there are alternative
high yield investment tools available, including wrap accounts, ELSs, and ELWs.
Number of people with financial assets over W1bn and totalassets
Most preferred investment tool among upper-tier investors(financial assets of over W1.0bn)
40
60
80
100
120
140
'06 '07 '08 '09 '10
100
150
200
250
300Financial a sset of the wealthy (RHS)
No. of wealthy in Korea (L HS)
('000 persons) (Wtn)
0
20
40
60
80
100
Inheritance Wage Business Financial
investment
Property
investment
1st choice
1st+2nd+3rd choices
(%)
Note: Wealthy refers to individuals with financial assets of more than W1bnSource: KB Research Institute
Note: 1+2+3 = respondents allowed to pick three preferred methodsSource: KB Research Institute
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2) Lack of track
record
In selecting financial assets, safety-oriented investors tend to prefer deposits in order to retain
assets, while aggressive investors tend to seek profitability via stocks and mutual funds. In
general, a solid past performance record is required to attract customers. Considering the
widely held belief that hedge funds are a high risk/high return form of investment vehicle,
capital inflow into the fledgling domestic hedge fund market is unlikely over the short term assuch a track record has yet to be established.
Looking at the growth pattern of global hedge funds, the market expanded rapidly over the
five-to-ten-year period following the launch thanks to a cumulative track record. In keeping,
we believe that any meaningful capital inflow into hedge funds will become possible only
once a sound performance track record is established.
3) Pension funds tend
to adopt conservative
stance
The growth of the domestic hedge fund market will likely be driven by the inflow of pension
funds. The National Pension Service (NPS) has said that it will diversify the distribution of its
investments by increasing the alternative investment portion from 6.4% in 2010 to over 10%
by 2016. Given the current low-interest rate environment, hedge funds should present an
attractive alternative investment down the road. However, looking at the short term, we point
out that Koreas pension funds face stricter investment restrictions than those placed on mostoverseas pension funds. Given such, the chances of large-scale capital inflow into hedge
funds with no proven track record would appear unlikely during the initial stages of the
domestic launch of these investment vehicles.
Global hedge funds: Growth limited in initi al stages NPS to increase alternative investment portion
0
500
1,000
1,500
2,000
2,500
'91 '94 '97 '00 '03 '06 '09
(US$bn)
0
5
10
15
20
25
30
35
'06 '07 '08 '09 '10 '12F '16F
Stock
Alternative investment
(%)
Source: Hennesee Group Source: NPS
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4) At present,
fledgling hedge fund
services lack
sufficient number of
experiencedprofessionals
Since their introduction in 2005, private equity funds (PEF) have been unable to achieve
significant grow in Korea due to an insufficient number of professionals (2005: W81tn
2010: W11.8tn). Of note, the key elements for hedge fund management are known as the
4Ps: People, Process, Performance, and Partnershipin particular, people
(professionals) are viewed as representing the most important factor in facilitating the growthof hedge funds.
In order for domestic securities firms to efficiently provide PBS, professional-level research,
transaction, and consulting services will all need to be firmly in place. At present, however,
Korea lacks a sufficient number of financial experts specializing in economy, finance,
accounting, tax, and law; moreover, there exist very few domestic hedge fund accounting &
administration companies.
5) Government
regulations to restrict
hedge funds asset
management
strategies
Upon the scheduled introduction of hedge funds in December, the equity long-short strategy
is highly likely to be adopted as the key approach for the funds. The fact that this strategy is
based on stock lending is viewed as presenting a difficulty as the domestic stock lending
market is very small compared to that of developed nations (comparison of stock lending and
borrowing ratioKorea: 2% vs US: 9.9%; UK: 4.0%; and Japan 9.7%) due to: 1) the typicallong-only strategy of existing growth-type funds; 2) unfavorable borrowing conditions
(commission rate of 3~4% for stock lending and short selling); and 3) strict government
regulations (legally bans on naked short selling and short selling of financial stocks).
Meanwhile, as naked short selling is banned, stock lending requires accompaniment. In
Korea, the roles of lenders-borrowers-brokers are clearly defined given that there is a limited
pool of stock lenders (pension funds, mutual funds, and individual stocks); therefore, the
domestic stock lending market is not as developed as that in most other major economies. Of
note, the ban on short selling has recently been lifted (excluding financial stocks); however, if
the market environment were to deteriorate, the possibility that the government would again
ban short selling cannot be ruled out. Accordingly, in order for hedge funds to adopt effective
asset management strategies, we believe a need exists to facilitate stock lending procedures.
Korea lacks a sufficient number of financial experts andmanagers
Global fund accounting & administrationcompanies
(Unit: Wbn)
CompanySize of hedge funds under
management
Citico Fund Services 482
Citi 228
HSBC Securities Services 217
Goldman Sachs Administration Services 212
The bank of New York Mellon 150
CACEIS Investor Services 137
SS&C Fund Services 115UBS Global Asset Management Fund Services 83
GlobeOp Financial Services 78
71.2
37.0 30.8
86.7
16.4
43.8 51.4
8.912.4 19.2 17.84.4
0%
20%
40%
60%
80%
100%
UK Hong Kong Singapore Korea
Suppor ting sta ff Experts Managers
PFPC Alternative Investment Group 72
Source: Ministry of Strategy and Finance Source: Hedge Fund Administrator Survey, IFSL
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Stock lending amount
In 1H11, balance of stock lendingrose to level seen at end-2007
(W24.7tn); however, slight declineseen over September-October due
to short selling ban (now lifted)
200
250
300
350
400
450
500
550
600
' 08 .1 0 ' 09 .1 ' 09 .4 ' 09 .7 ' 09 .1 0 ' 10 .1 ' 10 .4 ' 10 .7 ' 10 .1 0 ' 11 .1 ' 11 .4 ' 11 .7 ' 11 .1 0
5
10
15
20
25
30Balance ( RHS)
Number of outstandin g shares (L HS)
(mn) (Wtn)
Source: Dataguide Pro, media reports, Woori I&S Research Center
Hedge fund management st rategy
AlternativeInvestment
Hedge Funds
Event Driven
Relative Value
Long/Short EquityLong/Short EquityOpportunistic
Source: Woori I&S Research Center
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Initial hedge fund
market size
estimated at W30tn
(two years after the
introduction ofKorean-type hedge
fund)
At this point in time, it is hard to forecast the size of the hedge fund market as there is no
established track record. Assuming that 10% of capital flows out (within two years of the
introduction of Korean-type hedge funds) of similar-type products (eg, discretionary wrap
accounts, private-placement funds, discretionary and advisory-type investment accounts), and
if combining that amount with the initial asset size of hedge fund managers (W30bn*15managers), we expect the hedge fund market to be worth W30tn by 2014.
If assuming that the sales trend of domestic hedge fund managers is similar to that of foreign
fund managers in Korea (ie, more than triple-digit growth in two years), we expect the
domestic hedge fund market to grow to W54.2tn by 2015 and to W97.2tn by 2016.
Initial hedge fund market size estimated at W30tn (two years after introduction) (Unit: Wbn)
Category Amount Remarks
Seed money of hedge fund companies (1) 450Financial authorities sent inquiries on seed money provision to 15 companies planninghedge fund management
Hyundai Securities decided to invest W30bn~50bn
Discretionary wrap account + PEF + investmentadvisory and discretionary investment (2) 298,421 - Wrap account, investment advisory and discretionary investment as of end-Aug 2011- PEF as of end-Oct 2011
(2) * 10% (3) 29,842 Assuming capital flow of 10% within two years of introduction
Koreas initi al hedge fund size (1)+(3) 30,292
Note: Discretionary wrap account and PEF based on net assets; investment advisory and discretionary investment based on contract assetsSource: Media reports, KOFIA
Koreas hedge fund market size still small (roughlyW1tn~3tn)
Hedge fund market to amount to W30tn within two years ofintroduction
2.5
3.2
1.5
1.01.3
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
'06 '07 '08 '09 '10
(Wtn)
30.3
54.3
97.2
174.2
0
50
100
150
200
'14F '15F '16F '17F
(Wtn)
Assuming CAGR of 79%
Source: KITMC Note: Applied initial sales growth of overseas funds in the domestic marketSource: Woori I&S Research Center
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New revenue sources
from introduction of
Korean-type hedge
fund: PBS and direct
management services
Upon the introduction of hedge funds, the key sources of revenue for securities firms will
likely be generated from PBS and the direct management of hedge funds. Given that domestic
prime brokers are banned from engaging in hedge fund management, hedge funds are likely
to be managed by spinning off a subsidiary or a separate division. Securities firms which meet
the minimum capital requirement (more than W1tn) will be allowed to directly manage hedgefunds; however, when considering the conservative nature of proprietary trading in Korea, we
expect only a small number of securities firms to engage in the management of hedge funds
during the initial market development phase.
Prime brokers handle financing (eg, stock lending & borrowing, credit lines), custody (eg,
retaining and managing hedge fund assets, clearing & settlement (eg, transaction settlements,
liquidation), and reporting (eg, providing reports to fund investors)of note, the key source
of revenue for prime brokers comes from financing.
Contribution of PBS
to securities
industrys annual
income to amount toroughly W200bn by
2014
PBS sales growth and hedge fund market growth tend to go hand in hand. Accordingly, upon
the introduction of a hedge fund, this correlation enables securities firms to generate new
revenue through the offering PBS. As there is no matching data available in Korea, we have
referenced the US hedge fund market in order to estimate the potential size of new revenuesthat Korean securities firms will be likely to generate as the market develops.
According to the TABB Group, the US hedge fund market reached US$1.5tn in 2010, with
PBS income representing US$10bn or 0.7% of the market. Assuming that Koreas PBS
income also reaches the 0.7%-level of the hedge fund market, we estimate the income
contribution of domestic PBS will reach W200bn pa within two years following the
introduction of hedge funds.
Income contribution
to hinge on
government
regulations and
availability of skilled
professionals
Assuming the market shares of the five companies registered to offer PBS (Daewoo
Securities, Samsung Securities, Woori I&S, Hyundai Securities, and Korea Investment
Securities) remains at the same levels, we calculate the sales contribution of each company
would reach around W40.0bn in the initial stages of the domestic introduction of hedge funds.
Nonetheless, actual market size may turn out smaller than estimated due to negatives such as
regulations and a lack of skilled, experienced professionals.
PBS offered by hedge funds PBS income mostly comes from stock lending
20
25
30
40
40
45
50
55
70
0 20 40 60 80
Credit lines
Capital introduction
Risk management
Custody services
Fund a dministration
Clearnan ce and settlement
Trade ex ecution
Cash lending
Securities lendin g
(%
Credit lines
Securities
lending
Trade
execution
and WM
Attracting
investorsCommission
income
Note: % refers to portion of prime brokers offering each serviceSource: IFSL Research
Source: Bernstein Research
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Koreas hedge funds
Criteria Remarks
Asset mgt companiesCombined deposits of over W10tn, including private funds, public
funds, and discretionary accountsSecurities firms Shareholders equity of over W1tn
Running both hedge fundbusiness and PBS not allowed
Investment advisory Discretionary contracts of over W500bn
Source: Press reports, Woori I&S Research Center
Operating income from PBS (Units: Wbn)
2014F 2015F 2016F 2017F
Koreas hedge fund market size 30,292.1 54,266.9 97,216.6 174,158.9
PBS income (A) 201.9 361.8 648.1 1,161.1
Operating income by company (A/f ive companies) 40.4 72.4 129.6 232.2
Note: Operating income of each company estimated assuming market share remains the same for Daewoo Securities, Samsung
Securities, Woori I&S, Korea Investment Securities, and Hyundai SecuritiesSource: Woori I&S Research Center
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3. Dilution of ROE from rights offering > revenue from new resources
Securities sector to
turn around in 2012
We believe the stock market to be strong in 1H12, but weaken in 2H12. Expecting an easing
of European fiscal crisis-related fears, we estimate the Kospi will rise to 2,300p in 1H11.
Upon the anticipated stabilization of the eurozone sovereign debt situation, preference forrisky assets should increase, boosting the Kospi and thus boding for the securities industry.
Despite customer deposit usage fee hikes and pressure for commission cuts, our overall view
toward the industry environment is positive, citing: 1) anticipation of a more favorable
industry environment in the long run following the introduction of hedge funds; and 2) likely
greater investment opportunities stemming from the scheduled easing of NCR regulations.
Combined net profit
of four securities
firms under our
coverage to grow
21.5% y-y in FY12
We believe net profit in the sector will fall 6.2% y-y in FY11 due to: 1) likely losses at trading
units stemming from higher market volatility amid external uncertainties (including the
European fiscal crisis); 2) likely lower WM commission income due to decreased wrap
account balances; and 3) one-off expenses at some securities firms (eg, Daewoo Securities
loss related to China Gaoxian Fibre Fabric Holdings).
However, net profit should climb 21.5% y-y in FY12 for the four companies under our
coverage. Nonetheless, considering rights offering to meet shareholders equity requirement
for entry into PBS, the average ROE for these four players is unlikely to show meaningful
improvement in FY12.
As such, we expect the single-digit ROE growth witnessed since 2007 to continue, believing
significant improvement is unlikely to be experienced in FY12 (FY10 10.4% FY11E 8.9%
FY12F 9.4%)
Combined net profit of companies under our coverage and y-y growth
Combined FY12 net profit of fourcompanies under our coverage to
grow 21.5% y-y
0
200
400
600
800
1,000
1,200
FY07 FY08 FY09 FY10 FY11E FY12F
-50
-40
-30
-20
-10
0
10
20
30
40
50Combined NP (LHS)
y-y (RHS)
(Wbn) (%)
Note: Samsung Securities, Daewoo Securities, Mirae Asset Securities and Kiwoom SecuritiesSource: Company data, Woori I&S Research Center
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Regulations on
industry aimed at :
1) protection of
investors; and
2) improvingindustry
environment
To date, domestic regulations on the securities industry have focused on protecting investors,
and have thus tended to be unfavorable for securities firms.
Here, we look at two sets of major government policies that will likely affect the profitability
of securities firms in 2012: 1) measures aimed at protecting investors and easing their burden;
and 2) the launch of PBS and hedge funds. Unlike the government regulatory efforts, webelieve the governments decision to allow the introduction of hedge funds will prove to be
positive for securities firms, serving as a new source of revenue going forward. In addition,
the easing of NCR criteria to 250% will likely be positive for the industry over the mid- to
long term.
Investor protection
measures to impact
negatively over near
term, but improving
business
environment to
positively impactover mid- to long
term
As stated, it is our view that both the launch of hedge funds and the easing of NCR criteria
will provide attractive investment opportunities for securities firms down the road. However,
it is also our view such favorable measures are unlikely to boost income to a significant
degree over the near term.
Turning to the investor protection measures unveiled in Sep 2011 (details to be finalized by
end-2011), it is our opinion that these regulations will hurt sector earnings over the near term.
Weighing all of the above, we believe thatover the short termthe pressure on income
from the new investor protection measures will exceed the income growth from new hedge
fund-related business ventures.
Planned launch of hedge funds: Investor protection measures vs PBS
2006 2007 2008 2009 2010
Reduce margin buyingand promote margin
transactions
Permit new securities bizPermit securities biz tooperate futures biz
Control PF risk
2011
Daily call money100% of
shareholdersequity
Call money reducedto 25% of
shareholdersequity
Lower trading feesand interest rate on
overdue loans
Minimum marginrate for margin
transactions(40%)
Minimummaintenance
requirement rateof collateral
(140%)
Settlement servic e
Improve policies onELS issuance and
operations
Allow investors toshift fund sellers
Ceiling of fund fees
Improve wrap account
Improve ELWmarket
2012E
PBS likely inline with
hedge funds
Protectinvestors and
lessenfinancialburden
(raising rateson customer
deposit)
Source: Woori I&S Research Center
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Government
measures to protect
investors and lessen
their financial
burden to undermineearnings
In order to protect investors and lessen their financial burdens, securities firms have expressed
their willingness to lower commissions and interest rates on overdue brokers loans. Large
securities firms are expected both to temporarily cut the commissions on stocks, futures, and
options trading and by end-2011 and to lower interest rates on overdue loans by 2~6%p.
We believe these efforts will have no significant impact on securities firms earnings. Cuts inbrokerage commissions (0.4623bp for Daewoo, Samsung, and Woori; 0.54bp for Hana
Daetoo) should reduce FY2010 operating income by 0.3% for Daewoo, 0.5% for Samsung,
0.3% for Woori, and 1.0% for Mirae. In addition, as customers with overdue brokers loans
account for only 2% of the total number of customers, lower interest rates on overdue loans
will likley have only a marginal impact on income.
Summary of governments investor protection measures
Remarks
Investors deposit usage fees Securities firms will need to pay a reasonable deposit usage fee to investors in
reflection of expected rate of returns on deposits
Advisory-type wrap account fees
Upfront fees (sales fee) represent high portion of discretionary investmentmanagement fees Fee system revision needed
Interest rate on delinquent brokersloan
In consideration of low credit risk, lower interest rate on delinquent brokers loansFund sales commission charge
For long-term investors (4yrs or longer), avg sales commission charge to belowered to 1.0%
Fees comparison and disclosure
Recognition that disclosure of brokerage commissions and brokers loan ratecomparison has been insufficient
As brokerage commission system becomes simplified, it should become easier tocompare commissions
Need to strengthen disclosure of consulting service fees Need to disclose advisory-type wrap account fee system (to allow investors to
make comparisons) Expects indirect fee cuts to be facilitated via comparison disclosure
FX marginFees
Need to disclose FX margin fees Such disclosure to lead indirectly to fee cuts
Source: FSS
Impact of cuts in brokerage commissions (Unit: Wbn)
Samsung Daewoo Woori Mirae Industry
Operating income (FY2010) 2,501.6 3,524.4 3,779.2 1,423.8 47,407.1
Likely decrease in operating incomefollowing commission cuts
11.6 10.6 10.7 14.7 161.7
Likely impact (%) on operatingincome
-0.5% -0.3% -0.3% -1.0% -0.3%
Source: FSS, Woori I&S Research Center
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Rise in customer
deposit usage fee to
undermine
profitability
However, a rise in customer deposit usage fees would likely have a substantial impact on
income. Currently, securities firms receive a 2.32~2.9% yield on customer deposits from
Korea Securities Finance Corp, while charging a 0~2.65% usage fee for investors. As income
from customer deposit usage should account for 7~24% of operating profit, any rise in the
usage fees will likely negatively impact earnings of securities firms. We estimate that aconservative 1%p rise in customer deposit usage fees would reduce operating profit 11.4% for
Kiwoom (largest impact) and 3.6% for Mirae (smallest impact).
Likely Impact of 1%p increase in customer deposit usage fees on operating profit (Units: Wbn)
Samsung Daewoo Woori Mirae Kiwoom
Reserve for claims of customer deposit (A) 2,405 1,870 875 658 1,560
Yield on A (B/A) 2.5% 3.5% 3.2% 2.9% 2.3%
Usage fee (C/A) 0.6% 1.3% 0.8% 0.9% 0.2%
Valuation gains on reserve for claims of customer deposit (B) 59.5 65.3 28.4 19.4 36.4
Customer deposit usage fees (C) 15.1 24.8 6.8 6.0 3.8
Customer deposit related gains (B-C) 44.4 40.5 21.6 13.4 32.6Operating profit 356.4 332.6 165.0 182.1 137.2
Portion (%) 12.5% 12.2% 13.1% 7.4% 23.8%
Assuming 1%p increase in usage fee
Operating profit decrease 24.0 18.7 8.8 6.6 15.6
Impact on operating profit -6.7% -5.6% -5.3% -3.6% -11.4%
Note: FY10 cumulative (K-GAAP non-consolidated basis)
Source: Company data, Woori I&S Research Center
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Resumed pressure to
lower advisory wrap
account fees
In 2010, wrap accounts increased sharply in line with the bullish stock market, driving up
asset management-related commission income. However, the securities sector index fell in
fear of lower profitability following new regulations on advisory wrap account fees.
Recently, the government took issue over the high portion of total advisory wrap account fees
represented by advanced fees (48.7%), indicating it might institute another fee cut.
For now, Korean Investment Securities and Hana Daetoo have said that they would cut their
fees from an average of 2.6~2.8% to 2.4% and from an average 2.5% to 2.3%, respectively
other securities firms are considering similar moves.
WM fees unlikely to
improve sharply
In the wake of external uncertainties, the net asset value of advisory wrap accounts has fallen
sharply. Until these uncertainties fade, we do not believe that wrap accounts will yet fully
rebound to the pre-financial crisis level (W8~9tn-level). Moreover, given possible cuts in fees
on advisory wrap accounts, WM commission income is unlikely to improve sharply over the
near term.
Regulation on advisory wrap account fees underminingsecurities sector index
WM commission income unlikely to improve sharply y-y
0
2,000
4,000
6,000
8,000
10,000
'10 .4 ' 10 .7 ' 10 .10 '11 .1 ' 11 .4 ' 11 .7 ' 11 .10
1,500
1,700
1,900
2,100
2,300
2,500
2,700
2,900
3,100
3,300
Advisory Wrap (LHS)
Sector ind ex (RHS)
(P)(Wbn)
0
100
200
300
400
500
FY08 FY09 FY10 FY11E FY12F
(Wbn) To remain flat
Source: Kofia, Dataguide Pro Note: Based on sum of four securities firms in Woori coverage (Samsung, Daewoo,Mirae, Kiwoom); Asset management fees are the sum of fees on BCs, wrapaccounts, and trust accounts
Source: Company data, Woori I&S Research Center
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Conclusion:
Earnings downside
to outweigh gains
from hedge funds
over short run
Given an anticipated stock market rebound following the expected fading of the European
fiscal crisis and likely improved net trading value amid the low interest-rate environment, we
foresee industry conditions improving y-y in 2012. However, we view it as unlikely that
hedge funds will significantly contribute to earnings over the short run, believing it will be
difficult to raise ROE to a degree sufficient to offset EPS dilution caused by rights offeringsin the near term. Moreover, we note that some signs exist that the government may tighten
regulations on commissions. Weighing all of these factors, we believe that sector ROE will
require more time to see a meaningfully increase.
Valuation table (Units: Wbn, won, %, x)
Samsung Daewoo Mirae Kiwoom Avg
Rating Buy Hold Buy Buy Neutral
Target price 65,000 12,000 43,000 75,000
Share price (11/18) 50,000 10,100 32,100 55,500Upside 30.0 18.8 34.0 35.1
Net profit FY10 238.3 256.2 142.1 111.5FY11E 275.0 181.9 137.5 107.1
FY12F 293.1 271.0 166.0 122.3
Shareholders equity FY10 2,798.7 2,863.3 1,889.3 690.4
FY11E 3,426.8 3,950.7 1,984.9 787.0
FY12F 3,638.1 4,154.6 2,119.4 893.8
ROA FY10 1.8 1.4 1.6 3.8 2.2
FY11E 1.9 0.9 1.1 3.0 1.7 FY12F 1.8 1.2 1.2 3.2 1.8ROE FY10 8.8 9.0 7.8 16.0 10.4
FY11E 8.8 5.3 7.1 14.5 8.9
FY12F 8.3 6.7 8.1 14.5 9.4
EPS FY10 3,686 1,365 3,423 5,047
FY11E 3,956 717 3,282 4,846FY12F 3,945 842 3,962 5,532
P/E FY10 21.9 16.4 13.7 16.0 17.0
FY11E 12.6 14.1 9.8 11.5 12.0
FY12F 12.7 12.0 8.1 10.0 10.7
BPS FY10 43,286 14,318 45,507 29,731
FY11E 46,118 11,823 47,380 35,613
FY12F 48,962 12,433 50,593 40,445
P/B FY10 1.9 1.6 1.0 2.7 1.8
FY11E 1.1 0.9 0.7 1.6 1.0
FY12F 1.0 0.8 0.6 1.4 1.0
DPS (FY10) 1,250 400 750 800
Dividend yield (FY10) 1.6 1.8 1.6 1.0 1.5
Source: Company data, Woori I&S Research Center estimates
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Securities Industry www.wooriwm.com
IV. Share price momentum positive over longer term; but soft in
near term
1. Valuations nearing histor ic low; unlikely to rise over near term
Following stagnate
earnings over past
three years,
valuations continue
to fall
Currently, the securities sector is trading at a P/B of 0.74x, far lower than the P/Bs following
the 2008 financial crisis or during the period of sector losses in 2005of note, the post-2005
P/B average is 1.15x.
While the Kospi has bounced back to the pre-2008 crisis level, the securities sector index has
yet to make significant progress due to stiff competition. If sector players are to regain the
premiums enjoyed in the past, we believe earnings will have to improve substantially.
In our view, despite rising trading volume, securities firms have failed to improve their
profitability due to competition over lower commissions. Moreover, we note that the overall
ROE of domestic sector playerswhich are highly dependent on brokerage commissions
has continued to fall.
Sector trailing Kospi due to stagnant ROE: Price trend Sector trailing Kospi due to stagnant ROE: Premium trend
-10
-50
5
10
15
20
25
30
35
'05.3 '06.6 '07.9 '08.12 '10.3 '11.6
0.0
0.5
1.0
1.5
2.0
2.5
3.0ROE (LHS)
P/B (RHS)
(%) (x)
0.0
0.5
1.0
1.5
2.0
2.5
'05.1 '06.1 '07.1 '08.1 '09.1 '10.1 '11.1
(x)
Post-2005
average P/B of
1.1x
Current P/B of0.74x
Note: Based on overall sector
Source: FSS
Source: FnGuide, Woori I&S Research Center
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Securities Industry www.wooriwm.com
Explosive trading
volume growth
unlikely
In the past, the securities sector index has largely outperformed the Kospi. Prominent
examples include 1999 (when stock trading volume grew explosively), 2005 (when securities
firms earnings improved sharply after having turned to profit), and 2007 (when expectations
for enactment of capital market consolidation act were riding high).
For the time being, with no new revenue sources currently in place and in order to make upfor deteriorating margins caused by intensifying competition, brokerage income-dependent
securities players would likely need to see a large-scale increase in stock trading volume (an
event which we view as being unlikely) in order to experience a significant expansion in their
brokerage income, net interest income, and net trading income figures.
However, in our view, stock trading is unlikely to significantly expand in the near future,
noting thatwhile we expect the risks to ease next yearit will take at least several years
before a fundamental resolution for the European fiscal crisis to be found, and believing that
double-dip fears over US economy will continue to linger. Furthermore, given our earlier-
described belief that expected positive structural changes fro the sector following the
scheduled introduction of hedge funds are unlikely to lead to tangible short-term earnings
generation for securities firms, we hold the opinion that a steady share price rise for securities
firms is unlikely in the short term.
Securities sectors past outperformance to the market
0
500
1,000
1,500
2,000
2,500
'98.2 '99.10 '01.6 '03.2 '04.10 '06.6 '08.2 '09.10 '11.6
0
1,000
2,000
3,000
4,000
5,000
Kospi index (LHS)
Securities sector index (RHS)
(P) (P)
Trading volu me
expansion Strong earnings
improvement
Expectations for capital
market consolidation act
Note: Based on 12M Forward P/BSource: Dataguide Pro, Woori I&S Research Center
Explosive trading volume expansion in 1999 Securities improv ing earnings (TTP) in 2005
0
2
4
6
8
10
12
14
'98.2 '00.8 '03.2 '05.8 '08.2 '10.8
0
1,000
2,000
3,000
4,000
5,000Trading volume(LHS)
Securities index(RHS)(Wtn)
Explosive trading
volume expansion
(P)
-600
-300
0
300
600
900
1,200
1,500
'0 3.1 2 '0 5.3 '06 .6 '07 .9 '0 8.1 2 '1 0.3 ' 11 .6
-10
-5
0
5
10
15
20
25
30
35NP (LHS)
ROE (RHS)
(Wbn) (%)Sharp earningsimprovement
Source: Dataguide pro Source: KOSCOM
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Securities Industry www.wooriwm.com
2. Investment strategy: Suggest range-bound trading based on short-term
momentum; over long term, suggest buying shares below P/B of 0.7x
Some government
policies to befavorable for
securities firms
Despite the earlier-discussed likely negative short-term impact on financial sector players of
most of the governments proposed new regulatory measures, we recognize that some ofKorean governments financial policies should be favorable for the securities sector. While it
is true that securities firms will not be entirely spared from regulatory risks (including
pressure to lower commissions), the 2012 regulatory environment is expected to be favorable
for the securities sector in light of the scheduled lowering of the NCR requirement to 250%,
the introduction of ATS, and the approval of hedge funds.
However, given thatdespite a rise in the Kospisecurities sector valuations have continued
to decline due to high market doubts over the likelihood of new revenue sources, we believe
that market premiums for securities sector shares will only be seen once the above-listed
positives actually translate into improved earnings.
Recommend taking
advantage of short-
term momentum bybuying on dips
As discussed earlier, the overall market environment has been turning in a favorable direction
for the securities sector in light of: 1) likely increased financial assets stemming as baby
boomers enter retirement age; 2) the launch of PBS upon the scheduled introduction of hedgefunds; and 3) expected ample market liquidity. However, looking at 2012, we believe these
positive factors are unlikely to resolve the securities sectors fundamental problem of low
operating margins.
We note thatdepending on developments related to the European fiscal crisis and
introduction of hedge fundssecurities shares are expected to fluctuate wildly. Thus, over the
short term we recommend a strategy which takes advantage of short-term momentum by
buying on dips. Given this expected environment, it remains to be seen whether the securities
sector will be able to show a steady rise similar to that seen in 2007.
Additional downside
risk limited, at P/B of
0.7x or below level
Following the financial crisis, the banking and insurance sectors rebounded in line with the
market rebound. Currently, despite the shaky stock market amid the European fiscal crisis,
these sectors receive a higher valuation than that which was seen during the financial crisis.
However, given that securities shares are now trading at a valuation level similar to that seenover 2005~2006, when securities firms were in the red (P/B of 0.6~0.8x in 2005), we view
sector shares as very attractive in terms of valuation. Furthermore, we note that securities
have also strengthened their shareholders equity sharply, believing the chances of securities
again posting losses are slim within the foreseeable future. Thus, considering likely overall
structural changes over the mid- to long term, we believe downside risk is limited when
securities are trading at a P/B of 0.7x or below.
Financial sector P/Bs Securities shareholders equity has risen steadily
0.0
0.5
1.0
1.5
2.0
2.5
Ba nkin g Se cu ritie s In su ra nce Cre di t ca rd
'08'09
'10
'11.10
(x )
20.1
26.828.9
32.434.7
0
5
10
15
20
25
30
3540
FY06 FY07 FY08 FY09 FY10
(Wtn)
Note: For insurance sector, 2008 figure based on average of top-five non-lifeinsurance companies as life insurers were not listed in 2008Source: Dataguide Pro
Note: Sum of domestic securities shareholders equitySource: KOSCOM
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Securities Industry www.wooriwm.com
Top pick: Kiwoom
Securities
Samsung Securities
also deserves
attention
We recommend Kiwoom Securities as a top pick for the securities sector, highlighting the
high possibility that the company will enjoy a valuation premium rise in line with improving
market conditions. In addition, we believe Samsung Securities deserves attention.
Based on its attractive 1.5bp commission rate, Kiwoom Securities has established a solid
brand image as a leader in online trading. Of note, in early-2011 Hanwha Securities startedoffering a lower commission rate than that of Kiwoom; however, Kiwooms market share
actually expanded further following this challengewe believe that this occurence well
illustrates the fact that Kiwoom has been expanding its loyal retail client base. Considering
the stable earnings generation from its brokerage unit (more than 1,000 new accounts are
being opened on a daily basis), the company deserves a premium to the market in our view.
Also, if Kiwoom were to succeed in acquiring a savings bank in the future (which it has
attempted to do in the past), such an acquisition could be expected to expand Kiwooms
lending capacity (brokers loans), thus leading to a likely share price re-rating.
Also warranting attention in our view is Samsung Securities. As the largest wealth
management securities company in Korea, Samsung Securities should enjoy a rising premium
in line with a likely increased portion of individual financial assets. Moreover, the company is
expected to be the frontrunner in hedge fund product sales.
Kiwoom Securities brokerage market share on steadily rise
0
2
46
8
10
12
14
16
18
'08.1 '08.5 '08.9 '09.1 '09.5 '09.9 '10.1 '10.5 '10.9 '11.1 '11.5 '11.9
Kiwoom.com Mira e Asse t
Samsung Daewoo
Woori
(%)
Note: Excluding ELWsSource: Industry data
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Securities Industry www.wooriwm.com
Samsung Securities: P/B band Daewoo Securities: P/B band
0
20,000
40,000
60,000
80,000
100,000
120,000
'06 '07 '08 '09 '10 '11 '12
Share price 3.2x2.4x 1.8x1.3x .8x
(won)
0
5,000
10,000
15,000
20,000
25,000
30,000
35,000
40,000
'06 '07 '08 '09 '10 '11 '12
Share price 3.0x2.4x 1.8x1.2x .6x
(won)
Source: Dataguide pro, Woori I&S Research Center Source: Dataguide pro, Woori I&S Research Center
Mirae Asset Securities: P/B band Kiwoom Securities: P/B band
0
40,000
80,000
120,000
160,000
200,000
'06 '07 '08 '09 '10 '11 '12
Share price 4.4x3.2x 2.4x1.5x .6x
(won)
0
20,000
40,000
60,000
80,000
100,000
'06 '07 '08 '09 '10 '11 '12
Share price 4.4x3.2x 2.4x1.5x .6x
(won)
Source: Dataguide pro, Woori I&S Research Center Source: Dataguide pro, Woori I&S Research Center
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www.wooriwm.com
Samsung Securities(016360.KS) Company AnalysisNov 25, 2011
Samsung Securities to maintain its lead
Initiate coverage at Buy and a target price of W65,000
We initiate coverage on Samsung Securities with a Buy recommendation and a
target price of W65,000.
Our target price is the arithmetic mean of its theoretical P/B-based fair value of
W54,000 and historical P/B-based fair value of W75,875 (target multiple of 1.6x
applied to our FY2011 BPS forecast of W46,118), and offers 30.0% upside.
Superior competitiveness in WM market to strengthen further
As the play is a leader in the WM market, Samsung Securities has lost some of its
premium due to the recent contraction of the wrap account segment. However, the
contraction is mainly a decrease in Samsung Securities NAVdue to volatility in
the marketand both Samsungs HNW client base and competitiveness of its
asset management business remain intact.
For the time being, a rebound in the wrap account market appears unlikely;however, when the wrap account market does recover, Samsung Securities share
premium should rise in line with it. In addition, hedge fund product sales have the
ability to boost Samsungs growth potential.
Capital expansion at minimum levels; smaller dilution burden than peers
ROE dilution effects caused by the rights offering (to raise capital for PBS) should
be smaller for Samsung Securities than for other securities firms as Samsung has
reduced the rights offering amount to a bare minimum. Considering that tangible
earnings generated by the hedge funds are unlikely to be generated in the short
term, we are encouraged by the likely limited EPS dilution.
In line with the rising portion of financial assets in individual asset portfolios,
Samsung Securities WM business should enjoy sustained growth momentum
thanks to its competitiveness in product design and sales capability. Currently,
Samsung Securities shares are trading at a FY2011 P/B of 1.1x (as of Nov 18)
versus an average P/B of 1.6x (over the last three years). Considering the above,
we believe Samsungs shares will rebound going forward.
Price Trend
0
50
100
150
200
'10. 11 '11.1 '11. 3 '11.5 '11.7 '11.9 '11.11
Samsung Securities
KOSPI
NOI Chg OP Pre-tax profit NP BPS EPS Chg PER PBR ROE ROAYE-Mar
(Wbn) (%) (Wbn) (Wbn) (Wbn) (won) (won) (%) (x) (x) (%) (%)
2009 866 14.7 316 319 245 40,246 3,799 6.7 16.1 1.5 9.8 2.0
2010 977 12.9 356 338 238 43,286 3,686 -3.0 21.9 1.9 8.8 1.8
2011E 1,058 8.3 356 357 275 46,118 3,956 7.3 12.6 1.1 8.8 1.9
2012F 1,165 10.1 386 387 293 48,962 3,945 -0.3 12.7 1.0 8.3 1.8
2013F 1,296 11.2 427 427 324 52,120 4,357 10.5 11.5 1.0 8.6 1.9Note: FY2009~2010 figures based on K-GAAP; FY2011 and afterwards based on IFRS non-consolidatedSource: Woori I&S Research Center estimates
Buy(Initiate)
Analyst
Dahee Woo822)768-7137, [email protected]
TP W65,000(Initiate)CP(11/11/18) W50,000
Sector Securities
KOSPI 1,839.17KOSDAQ 503.09Market cap (common) US$3,355.84mnOutstanding shares (common) 66.8mn shrs
52W high (11/01/14) W97,100low(11/10/05) W45,450Dividend yield (FY10) 1.6%Foreign ownership 19.5%
Major shareholders
Samsung Life 11.4%Samsung F&M 7.7%
Share performance (%)1M 6M 12M
Absolute -22.0 -38.2 -20.7Relative -20.9 -24.3 -16.1
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Samsung Securit ies www.wooriwm.com
2QFY11 earnings preview and earnings outlook
2QFY11 preview:
Net profit of
W54.3bn due toreduced WM income
Despite difficult market conditions in 2QFY11, Samsung Securities is expected to post
relatively small proprietary trading losses compared to other securities firms. Despite a q-q
rise in average daily trading value (1QFY11 W9.2tn
2QFY11 W9.4tn), its brokeragecommission income was likely flat q-q as online trading accounted for a growing portion of
its total trading value. Meanwhile, the company will likely post an IB commission income of
W8.8bnslightly higher q-q (W7.1bn recorded in 1QFY11).
However, its advisory-type wrap account balance contracted sharply, from W3.4tn in 1QFY11
to W2.4tn in 2QFY11, which led to a W20bn decline in its WM income. We believe Samsung
Securities will post 2QFY11 net profit of W54.3bn.
WM and client-based
strength
Recently, WM capability has become a potential core competitive point at securities
companies. Samsung Securities has excelled in WM business thanks to its superior strength in
attracting clients and selling products.
For the time being, we do not expect the wrap account market to grow strongly given
government regulations impacting advisory-type wrap accounts and intensifying market
competition (triggered by other securities firms cutting their wrap account commissions).
However, considering that the fall in the companys customer deposits (from W114tn at end-
July to W100tn at end-September) is attributable to a fall in NAV and not to customer flight,
the plays shares should trade at a premium (vs peers) when the stock market rebounds.
In addition, Samsung Securities is expected to grow steadily over the longer term as we are of
the opinion the company is capable of introducing a variety of products promptly, in line with
the anticipated growth of the hedge fund market.
Samsung enjoyed highest P/B premium along with explosive growth of wrap accounts
Strong WM capability to drawinvestor attention
0
1,000
2,000
3,000
4,000
5,000
6,000
'10.4 '10.7 '10.10 '11.1 '11.4 '11.7 '11.10
75
85
95
105
115
125Wrap account balan ce (LHS)
Samsung 's pre mium (RHS)
(%)(Wbn)
Note: Premium relative to the KospiSource: Samsung Securities, Dataguide Pro, industry data
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Samsung Securit ies www.wooriwm.com
Breakdown of net operating income Samsung has higher number of HNW customers than peers
44 47 40 44 37
3 3 4 5 4
16 15 12 11 18
11 912 12 16
1 11 1
21213 23 17 16
14 12 9 10 7
0%
20 %
40 %
60 %
80 %
100%
FY06 FY07 FY08 FY09 FY10
Net trading incomeNet interest incomeOther commissions
Sales commissions on derivatives-combined securitiesWMIBBrokerage
0
10,000
20,000
30,000
40,000
50,000
60,000
70,000
80,000
90,000
Samsung Woori Mirae Daewoo
(No)
Source: Samsung Securities, Woori I&S Research Center Note: HNW customersindividual investors with accounts of W100mn or more
Source: Company data
Samsungs wrap account balance more than double peers Valuation at historic lows
0
50 0
1,000
1,500
2,000
2,500
Samsung Mirae Korea Woori Daewoo
(Wbn)
0
20,000
40,000
60,000
80,000
100,000
120,000
'06 '07 '08 '09 '10 '11 '12
Share price 3.2x2.4x 1.8x1.3x .8x
(won)
Note: As of end-Sep 2011Source: Company data
Source: Dataguide Pro, Samsung Securities, Woori I&S Research Center
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Samsung Securit ies www.wooriwm.com
INCOME STATEMENT BALA NCE SHEET
(Wbn) 2011/03A 2012/03E 2013/03F 2014/03F (Wbn) 2011/03A 2012/03E 2013/03F 2014/03F
Operating inco me 2,502 2,834 3,105 3,200 Cash and deposits 3,256 3,585 3,773 3,910Net commission income 750 779 833 851 Cash and cash equivalents 225 939 988 1,024
Brokerage 358 392 427 426 Deposits 3,031 2,646 2,785 2,886
IB 34 30 36 42 Securities 7,997 9,417 9,648 9,839Wealth management 180 191 200 213 Trading securities 5,864 6,990 7,139 7,291Others 178 166 170 170 Securities available for sale 1,769 1,999 2,065 2,096
Net interest income 156 165 178 188 Securities using equity method 336 399 400 402Net trading income 3 -10 23 125 Structured securities 28 0 0 0Other income 68 124 130 131 Loans(net of allowance) 1,002 1,141 1,233 1,233Net operating income 977 1,058 1,165 1,296 Tangible Assets 79 81 81 82SG&A expenses 621 702 779 869 Other Assets 786 2,143 2,163 2,202
Salary 330 401 478 568 Total As sets 13,121 16,366 16,898 17,266Others 291 301 301 301 Deposits 2,716 2,902 3,054 3,165
Operating profit 356 356 386 427 Borrowings 6,926 7,512 7,549 7,551Non-operating profit -18 1 1 1 Other liabilities 680 2,526 2,657 2,677
Non-operating income 33 1 1 1 Total liabilit ies 10,322 12,940 13,260 13,393Non-operating expenses 52 1 0 0 Paid-in capital 346 394 394 394
Pre-tax profit 338 357 387 427 Capital surplus 1,145 1,547 1,547 1,547Income tax 100 82 94 103 Retained earnings 1,230 1,391 1,603 1,837
Tax rate (%) 29.5% 22.9% 24.2% 24.2% Capital adjustment + AOCI 78 94 94 94Net profit 238 275 293 324 Total shareho lder s equity 2,799 3,427 3,638 3,873
VALUATION INDEX
(%) 2011/03A 2012/03E 2013/03F 2014/03F 2011/03A 2012/03E 2013/03F 2014/03F
Brokerage 36.7 37.0 36.6 32.9 Investment indicators(x, won)
IB 3.5 2.9 3.1 3.3 BPS 43,286 46,118 48,962 52,120Wealth management 18.4 18.0 17.2 16.4 EPS 3,686 3,956 3,945 4,357Other commission 18.2 15.7 14.6 13.1 DPS(common shrs) 1,250 1,100 1,200 1,200Net interest income 15.9 15.6 15.3 14.5 PBR 1.9 1.1 1.0 1.0Net trading income 0.4 -0.9 2.0 9.6 PER 21.9 12.6 12.7 11.5Others 7.0 11.7 11.2 10.1 Dividend payout ratio 31.0 29.7 30.4 27.5
GROWTH RATE & PROFITABIL ITY Efficiency(%)
2011/03A 2012/03E 2013/03F 2014/03F Of total assets (%)
Growth(YoY,%) Net commission income 5.7 4.8 4.9 4.9Total asset -0.4 24.7 3.3 2.2 Net interest income 1.2 1.0 1.1 1.1Shareholders equity 7.7 22.4 6.2 6.4 Net trading income 0.0 -0.1 0.1 0.7Customers deposits 33.2 6.8 5.3 3.6 Of operating income (%)Net operating income 12.9 8.3 10.1 11.2 Net operating income 39.1 37.3 37.5 40.5Net commission income 18.9 4.0 6.9 2.2 SG&A expenses 24.8 24.8 25.1 27.2SG&A expenses 12.8 1