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A Crisis Cripples South Korea's Savings Banks

On the day in May she was supposed to have appeared before prosecutors for questioning, an executive of a shuttered South Korean savings bank hanged herself with her scarf in a Seoul motel. The woman, identified by the police only as “Kim,” was a credit officer at Mirae Mutual Savings Bank, whose chairman was caught fleeing to China in a fishing boat three weeks earlier. She’s the latest casualty in a scandal hitting the periphery of Korea’s banking industry for more than a year.

Since early 2011, regulators have closed 20 Korean savings banks, where risky real estate bets gone bad have wiped out the savings of many ordinary Koreans. Even the prime minister saw money disappear. Prosecutors’ probes have uncovered cases of illicit lending and lax oversight, leading to the indictments of nearly 200 people and at least two jail sentences. Four bank executives have committed suicide, according to police, while more than 88,000 depositors and bondholders, many of them retirees, saw 1 trillion won ($857 million) vanish. “Everyone’s become a victim,” says Nam Joo Ha, an economics professor at Sogang University in Seoul. “Regulators lost the people’s confidence. The savings bank industry lost trust, a financial company’s most important virtue, and the people lost their money.”

South Korea’s savings bank industry was born in the aftermath of Asia’s 1997-98 financial crisis. Regulators allowed private lenders and rural cooperatives to call themselves “savings banks” in 2001 to boost confidence in the usually tiny, regional lenders. The state then granted deposit protection comparable with the insurance at nationwide lenders. This allowed savings banks to grow. In 2006 the government eased lending rules and the banks expanded their scope to include the property market.

Real estate lending became the banks’ downfall when defaults increased following the global financial crisis in 2008. To survive, savings banks started selling customers subordinated bonds that had low priority for repayment in the event of default. Because of high annual yields—as much as 10 percent, almost double the savings account rates at national banks—the securities became popular, particularly among the elderly living on interest payments.

The most recent round of closings came on May 6, when the Financial Services Commission announced the shutdown of four lenders including Korea Savings Bank, whose more than 10,000 depositors included 50-year-old Je Mi Young. The Seoul housewife sat trembling in her pajamas that Sunday morning, as headlines streamed across her television screen delivering the news that the bank was out of business. Her savings would be protected by state-run Korea Deposit Insurance Corp. (KDIC), which guarantees as much as 50 million won. Still, the additional 40 million won bond investment she made on behalf of her mother would be wiped out. “I always wondered what kind of stupid people put precious money into messy banks,” says Je. “Now I am one of them.”

Prime Minister Kim Hwang Sik was also swept up in the bank closures. He lost 40 million won when the FSC shut down Seoul-based Jeil Savings Bank in September. Like other Jeil depositors, he eventually got his money back from the KDIC, says Choi Hyung Du, a spokesman in Kim’s office.

Jeong Gu Haeng, president of Jeil’s affiliated bank, Jeil 2, was the first to commit suicide. On Sept. 23, he jumped six floors from his downtown Seoul office, according to police. A credit officer at Tomato 2 Savings Bank, and the chairman of Ace Mutual Savings Bank also killed themselves, according to police.

The government is discussing how to raise the money needed to repay an estimated 1 million-plus depositors. The 70,650 customers who had amounts exceeding the 50 million won insurance limit, along with 17,445 bondholders, need to stand in line as debtors in bankruptcies and civil suits.

Customers have pulled their money from savings banks, sending deposits down 23 percent since the end of August to a four-year low of 54.8 trillion won at the end of March, according to Bank of Korea data. Kang Sin Ah, a 43-year-old Seoul office worker, in January moved 20 million won to a state-run lender from a savings bank that had been paying as much as 3 percentage points more in interest. “What’s the advantage, if I have a nightmare every day about losing it?” she says.

The bottom line: More than 88,000 depositors and bondholders saw $857 million of their savings vanish in the failure of 20 savings banks.

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Mitt Romney's Tax Savings

Photograph by Rick Friedman/CORBIS

By David J. Lynch, Lisa Lerer and Sabrina Willmer

When Mitt Romney conceded on Jan. 17 that he pays a tax rate of about 15 percent—far less than millions of wage earners whose votes he’s trying to win—he deflected criticism by employing what might be called the Ordinary Rich Guy Defense: Like a lot of people who are wealthy enough not to work, Romney said his income “comes overwhelmingly from investments made in the past.” That’s not quite the whole story. What he left out is that, because of the way he made his money, he is eligible to take advantage of a special tax provision that even some of his richest friends would envy.

Private equity executives such as Romney, who spent 15 years running Bain Capital, arrange to receive much of their compensation in the form of “carried interest.” This enables them to treat what would be work income for most people, taxed at rates up to 35 percent, as capital gains, taxed at just 15 percent. “It’s a method of converting one’s labor into capital gains in a way that’s unusual outside the investment management industry,” says Victor Fleischer, an associate law professor at the University of Colorado at Boulder whose 2007 paper on the topic helped spur calls in Congress to change the law. “Ordinary people wouldn’t be able to do this.”

For months, Romney dodged questions about his effective tax rate. “I paid the taxes required under the law,” he said on Jan. 11. That only increased curiosity. On Jan. 17, Romney conceded his effective rate was “probably” close to 15 percent. Though he retired from Bain in February 1999, Romney negotiated a settlement that has allowed him to continue benefiting from the firm’s lucrative private equity funds and to invest alongside them in so-called co-investment vehicles, both of which generate income taxed at the 15 percent rate. The tax code’s treatment of income from partnerships in private equity, hedge funds, and real estate development means that some of the richest people in the country are taxed as if they made the wages of a bus driver or health aide. Last year three founders of the Washington-based Carlyle Group each earned $275,000 in salary. But they took home $134 million apiece in distributions from their funds, according to a Securities and Exchange Commission filing, making them eligible to pay low rates on much of their compensation.

Private equity firms gather large sums from pension funds, universities, and wealthy individuals, and typically use the money to acquire privately held companies or subpar units of public companies. After improving the companies’ performance, often while working in hands-on management roles or serving on the board of directors, they sell their acquisitions to other investors or take them public. The tax code treats those gains as if the private equity partners were risking their own money—like average Americans who invest in mutual funds—instead of counting it as salary for running or advising the companies they acquire. In most cases, the private equity firms put up only a sliver of the fund’s capital.

In May 2004, Bain circulated a private-placement memorandum to investors for “Bain Capital Fund VIII.” Marked confidential, the document boasted that Bain had completed more than 200 deals as of March 2004. The firm’s first six funds had realized an 82 percent return, according to the document. In all, 274 investors signed on to the fund, including Romney and his wife, Ann, and pension funds for Texas teachers and Pennsylvania state employees.

The VIII fund, registered in the Cayman Islands, shows how special tax provisions allowed Romney to accumulate wealth both while running Bain and in the 13 years since he left the firm. The Romneys received more than $1 million from the fund in 2010, according to his most recent financial-disclosure form. Though Bain put up just 0.1 percent of the $3.5 billion fund’s capital, it drew 30 percent of the profits once investors were repaid their initial investment, better than the industry standard of 20 percent and a reflection of the firm’s stellar track record. The fund’s investment successes included the parent company of Dunkin’ Donuts, which paid investors a $500 million dividend after a successful November 2010 refinancing. A month later, the initial public offering of FleetCor Technologies in Norcross, Ga., brought in an additional $61 million.

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Banks Have Record $1.45 Trillion to Buy Treasuries on Savings

June 19, 2011, 12:05 PM EDT By Masaki Kondo, Yoshiaki Nohara and Saburo Funabiki

June 20 (Bloomberg) -- Japan’s biggest bond investors see increasing parallels between the nation’s government debt market and Treasuries, indicating that historically low yields in the U.S. have room to fall.

Just as in Japan, deposits at U.S. banks exceed loans, reaching a record $1.45 trillion last month, Federal Reserve data show. As recently as 2008, there were more loans than deposits. The gap is also at an all-time high in Japan, where banks use the money to buy bonds, helping keep yields the lowest in the world even though the country has more debt outstanding than America and a lower credit rating.

While none of the more than 40 economists surveyed by Bloomberg expect the U.S. will see two decades of stagnation like Japan, they are paring growth estimates as unemployment remains above 9 percent and the housing market struggles to recover. The International Monetary Fund cut its forecast for U.S. growth in 2011 for the second time in two months on June 17, bolstering the appeal of fixed-income assets.

“I’ve seen what happened in Japan, so when looking at the U.S. now, I think, ‘Ah, the same thing is going on,’” said Akira Takei, the Tokyo-based general manager of the international fixed-income investment department at Mizuho Asset Management Co., which oversees about $41 billion.

Savings Increase

In the decade before credit markets seized up in 2008, U.S. deposits exceeded loans by an average of about $100 billion, Fed data show. The worst recession since the 1930s led consumers to trim household debt to $13.3 trillion from the peak of $13.9 trillion in 2008, and increase savings to 4.9 percent of incomes from 1.7 percent in 2007, Fed and government data show.

Banks pared lending amid more than $2 trillion in losses and writedowns, according to data compiled by Bloomberg. Instead of making loans, financial institutions have put more cash into Treasuries and government-related debt, boosting holdings to $1.68 trillion from $1.08 trillion in early 2008, Fed data show.

Yields on 10-year Treasuries -- the benchmark for everything from corporate bonds to mortgage rates -- have fallen to less than 3 percent from the average of 6.79 percent over the past 30 years even though the amount of marketable U.S. government debt outstanding has risen to $9.26 trillion from $4.34 trillion in 2007, Treasury Department data show.

Ten-year yields fell 2.5 basis points, or 0.025 percentage point, last week to 2.94 percent in New York, the fifth straight weekly decline, according to Bloomberg Bond Trader prices. The price of the 3.125 percent security due in May 2021 rose 7/32, or $2.19 per $1,000 face amount, to 101 17/32.

Lending Drop

Loans dropped and savings rose in Japan, too. Lending has declined 27 percent from the peak in March 1996, while bank holdings of government debt surged more than fivefold to a record 158.8 trillion yen ($1.98 trillion) in April, according to the Bank of Japan. The difference in deposits and loans, known domestically as the yotai gap, is 165 trillion yen, or more than Spain’s annual economic output.

Yields on Japanese bonds due in 10 years dropped to 1.115 percent last week from 3.46 percent in 1996 and have remained at about 2 percent or lower since 2000.

The U.S. and Japan are “beginning to look similar because of the fact that we’ve had very low interest rates for a very long time now” Charles Comiskey, the head of Treasury trading at Bank of Nova Scotia in New York, said in an interview. “This is going to be 10 years of pain to de-lever ourselves from the mess of a debt-ridden society that we’ve become.”

Rates Outlook

Futures traded on the Chicago Board of Exchange indicated in January that the Fed would raise its target rate for overnight loans between banks from a record low of zero to 0.25 percent in 2011. After reports this month showed that the jobless rate rose back above 9 percent, consumer confidence fell, the housing market weakened and manufacturing slowed, traders now see no increase until late 2012 at the earliest.

The IMF said the U.S. economy will grow 2.5 percent this year and 2.7 percent in 2012, down from the 2.8 percent and 2.9 percent projected in April.

Further declines in Treasury yields may be limited because the inflation rate is higher than in Japan, where consumer price changes have been mostly negative since 2000.

U.S. prices rose 3.6 percent in May from a year earlier, according to the Labor Department. That means 10-year Treasuries yield 62 basis points less than the inflation rate. So-called real yields in Japan, where consumer prices rose 0.3 percent in April, are a positive 82 basis points.

Pimco Avoids

“Treasury bonds at the current valuation would likely disappoint long-term investors with low or even negative real returns,” Tomoya Masanao, the head of portfolio management for Japan at Pacific Investment Management Co., wrote in an e-mail to Bloomberg News. “The global economy seems more tilted to inflation than deflation over the next three to five years.”

Pimco, based in Newport Beach, California, had $1.28 trillion under management as of March 31, including the world’s biggest bond fund, the Total Return Fund. Bill Gross, the firm’s co-chief investment officer, has said mortgages, corporate bonds and sovereign debt of nations such as Canada are more attractive.

The median estimate of more than 50 economists and strategists surveyed by Bloomberg is for 10-year Treasury yields to rise to 4 percent over the next 12 months.

Those forecasts fail to take into account the weak U.S. housing market, which makes up the bulk of Americans’ net worth, according to Akio Kato, the team leader for Japanese debt in Tokyo at Kokusai Asset Management Co., which runs the $31.1 billion Global Sovereign Open fund.

Housing Tumble

“U.S. home prices won’t rebound unless household debt” is reduced, Kato said. “As long as the situation remains the same, bank lending won’t grow. U.S. banks will tighten criteria for borrowers."

House prices in 20 U.S. cities are 14 percent below the average of the past decade, according to the S&P/Case-Shiller index of property values. The gauge dropped in March to the lowest level since 2003. Japan’s land prices are still at less than half the level of two decades ago.

Japan has endured two decades of economic stagnation with nominal gross domestic product about the same as it was in 1991. Government debt is projected to reach 219 percent of GDP next year, the Organization for Economic Cooperation and Development estimates. That compares with about 59 percent in the U.S., government data show.

BOJ Nullified

The economy has struggled to recover even though the BOJ buys government securities monthly to lower borrowing costs and stimulate the economy. The efforts have been nullified as banks use BOJ funds to buy bonds rather than lend.

‘‘With no prospects for Japan’s economic growth, funds from the widening loan-deposit gap flow to bonds rather than stocks,” said Katsutoshi Inadome, a strategist in Tokyo at Mitsubishi UFJ Morgan Stanley Securities Co., a unit of the nation’s largest listed-bank.

That’s similar to the U.S., where economists are cutting growth forecasts even though the Fed has pumped almost $600 billion into the financial system since November by purchasing Treasuries under a policy known as quantitative easing. The program is due to end this week.

Mizuho’s Takei said there is a “very high chance” that lenders will continue to funnel deposits to the bond market, helping to push Treasury 10-year yields toward 2.4 percent within a few months. Takei said he favors longer-maturity securities.

“Eventually, yields in Japan and the U.S. will converge,” said Mizuho’s Takei. “This is just the beginning.”

--Editors: Philip Revzin, Rocky Swift

To contact the reporters on this story: Masaki Kondo in Singapore at mkondo3@bloomberg.net; Yoshiaki Nohara in Tokyo at ynohara1@bloomberg.net; Saburo Funabiki in Tokyo at sfunabiki@bloomberg.net

To contact the editor responsible for this story: Rocky Swift at rswift5@bloomberg.net

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HSBC Targets $3.5 Billion Cost Savings With Office, Job Cuts

May 11, 2011, 5:31 AM EDT By Stephanie Tong and Gavin Finch

(Updates with analyst comment in third paragraph.)

May 11 (Bloomberg) -- HSBC Holdings Plc, Europe’s biggest bank, will cut jobs and close offices as to reduce costs by about a tenth over the next two years to expand in faster- expanding economies and prepare for stricter capital rules.

The lender will target cost cuts of $2.5 billion to $3.5 billion by 2013, according to a statement today, compared with total operating expenses of $37.7 billion last year. HSBC will cut head office jobs and may sell its U.S. credit cards division as it seeks to exit unprofitable units among its 87 national subsidiaries, it said today. The shares fell in London trading.

The targets “are a reiteration of those announced with the full-year results,” Ian Smillie, an analyst at Royal Bank of Scotland Group Plc, said in a note to investors today. He has a “buy” rating on the stock. They “will disappoint those anticipating a revised round of more ambitious targets.”

Stuart Gulliver, 52, who became chief executive officer in January, said this week it may take as long as three years to reach the bank’s targets on reducing costs, which are the highest among its U.K. peers. He is spelling out the changes at a meeting with investors in London today. Competitors including Barclays Plc are also seeking to exit operations with low returns as regulators demand they hold more capital in the wake of the financial crisis.

‘Not About Shrinking’

“This is not about shrinking the business but about creating capacity to re-invest in growth markets and to provide a buffer against regulatory and inflationary headwinds,” Gulliver said. “We will continue to invest in markets with strategic relevance and high actual or potential returns and will either turn around or dispose of other businesses.”

The bank fell 0.9 percent to 650 pence at 9:57 a.m. in London, for a market value of 115.9 billion pounds. That marked the biggest decline in the FTSE 350 Index of Britain’s five biggest banks.

HSBC said it will focus on commercial banking globally, while scaling back in consumer banking to markets where it can “achieve profitable scale.” The lender said it will focus on retail banking in the U.K. and Hong Kong, high-growth markets such as Mexico, Singapore, Turkey and Brazil and smaller countries where it has a leading market share.

HSBC said it would cut $1.38 billion of costs by 2013 through measures including simplifying “regional structures,” consolidating data centers, shifting operations to cheaper cost locations, and reducing paperwork. The bank had 295,061 employees worldwide at the end of 2010 compared with 315,520 at the end of 2007.

‘Little Revolutionary’

“There is little revolutionary within the announcements,” Keefe, Bruyette & Woods Ltd. analysts including Mark Phin said in a note to clients today.

Costs rose to 60.9 percent of income in the first quarter from 49.6 percent, earnings figures showed on May 9. Net income rose 58 percent to $4.15 billion from $2.63 billion a year earlier. The bank has a target to increase revenue faster than costs, HSBC said today.

“We clearly have a cost problem,” Gulliver told investors today. “The team will address the issues of the firm with some energy.”

The first-quarter results, with emerging markets outperforming developed ones, showed that HSBC is “a developing-market bank trying to escape from the body of a very different type of ‘conglomerate bank,’” Mediobanca SpA analysts said in a note yesterday. HSBC is “immensely powerful” and its results showed structural flaws “that prevent it providing the kind of shareholder returns the bank should be capable of providing.”

U.S. Unit

HSBC, whose origins date back to 1865 when it operated as the Hongkong and Shanghai Banking Corp. to finance trade in opium, silk and tea, focuses on emerging markets. It has 7,500 offices.

The bank could free $25 billion of capital by selling its U.S. credit-card unit, Rohith Chandra-Rajan, an analyst at Barclays Capital, wrote in a note to investors last week.

HSBC acquired the credit-card unit in 2003 with its $15.5 billion purchase of U.S. subprime mortgage lender Household International, now known as HSBC Finance. In 2009, HSBC halted consumer-finance lending at the unit, which has contributed to about $60 billion of provisions in North America, according to data compiled by Bloomberg.

‘Lot of Inefficiency’

“HSBC has a lot of inefficiency and manages a lot of its processes on a region-by-region basis,” Cormac Leech, an analyst at Canaccord Genuity Ltd. in London, said before the statement was published.

The bank reiterated that it seeks a return on common equity of 12 percent to 15 percent. It lowered that goal in February from 15 percent to 19 percent.

HSBC could climb to about 950 pence a share if Gulliver committed to ensuring all businesses generate a return on equity exceeding 10 percent, Gareth Hunt, an analyst at Investec Securities in London, wrote in a note to investors last month. HSBC shouldn’t have “a flag in every country,” he wrote. The bank’s shares closed at 656.2 pence in London trading yesterday.

Among the bank’s peers, Barclays cut its target for return on equity in February to at least 13 percent from the 18 percent CEO Robert Diamond has said it averaged over the past three decades. Credit Suisse Group AG, Switzerland’s second-biggest bank, trimmed its goal to more than 15 percent from more than 18 percent.

--With assistance from Jon Menon in London. Editors: Francis Harris, Edward Evans.

To contact the reporters on this story: Stephanie Tong in Hong Kong at stong17@bloomberg.net; Gavin Finch in London at gfinch@bloomberg.net

To contact the editor responsible for this story: Edward Evans at eevans3@bloomberg.net

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