Korea Investment Holdings

2017. 5. 29

Sector Financials (OVERWEIGHT) Update Capital is everything

● The repeated tightening and loosening of capital-leverage regulations has characterized much of the financial sector's history, and today is no different- valuations have been rising on expectations of deregulation and interest-rate hikes.

● With the rally well underway, we advise focusing on financial players with the capital adequacy and execution capabilities required to lead change in the market landscape—firms with high capital ratios should be able to amass economies of scale through market-share gains and M&As, furthering their superiority in fundamentals over second-tier players and garnering higher valuations.

Sean Chang , CFA Analyst [email protected] WHAT’S THE STORY? 822 2020 7790 Deregulation expectations driving valuation recovery: Leveraging capital is at

the heart of the business of financial firms, but governments—wary of excess and weighing the need for economic growth against the risk of financial crisis—constantly move between tightening and loosening capital regulations. Recently, deregulation expectations have combined with interest-rate hikes to drive up financial stock valuations. Focus on fundamentals: Capital-leverage regulations impact not only on returns on equity and valuations (through deleveraging) but also the general market landscape— when rule tighten, better capitalized institutions tend to gain market share and acquire weaker players. JP Morgan is a case in point. After the 2008 global financial crisis, the company took advantage of its capital strengths to supplant Citigroup as the world’s largest investment bank. Jaewoo Kim Banks—capital adequacy a key differentiating point: Korean banks have largely Analyst [email protected] shed the capital-related discounts received since the 2008 crisis, but—with Basel III 822 2020 7848 standards set to be fully implemented from 2019—differences in common equity tier-1 ratios are translating into wider gaps in fundamentals and the ability to conduct M&As. David Lee Research Associate We advise focusing on banks with high capital-adequacy ratios that should lead to [email protected] differentiated earnings rather than taking a simple lowest-multiple approach. 822 2020 7768 Insurers—capital regulations to alter industry landscape: The market believes Eunsoo Lee insurers no longer need to recapitalize, as IFRS 17 standards will ease requirements and Research Associate many firms are set to issue subordinated and perpetual bonds. Once market-yield [email protected] volatility increases, however, we believe differences in capital power will result in more 822 2020 7809 pronounced disparities in the industry in the form of wider gaps in operational fundamentals and investment yields. Eventually this should trigger a restructuring of the industry. Brokers—eager to better utilize capital: With authorities scaling back regulations to foster the creation of massive investment banks that could compete on a globally, large securities brokers have sought scale via M&As and rights offerings, while smaller players have turned to specialty applications to survive While additional industry restructuring is unlikely, brokers more than ever are eager to better utilize capital. Investors should focus on companies that offer differentiated business models. Capital key to top picks: Our top financial sector picks are KB Financial Group, Samsung Life, Samsung Fire & Marine, and Korea Investment Holdings, which offer the capital strength needed to gain market share, flexible business strategies, and the potential to achieve economies of scale through M&As.

Financials

2017. 5. 29

Contents

All about leverage p2 Banks: Capital adequacy p11 already setting some apart Insurers : C oncerns over capital regulation tightening p30 can mount Securities Brokers: Business model differentiation p47 All about leverage underway to boost capital utilization efficiency Leveraging capital is at the heart of the business of financial firms, but governments—wary of excess Company p74 and weighing the need for economic growth against the risk of financial crisis—constantly move between tightening and loosening capital regulations. When regulations tighten, financial firms tend to deleverage at the expense of profitability, and their valuations decline. Once capital ratios are built up, the sector starts to recover. A recent easing of regulations has heightened expectations that financial sector valuations will recover. The Donald Trump administration’s desire for deregulation, epitomized by the passage of the Financial Choice Act 2.0 by the House of Representatives’ Financial Services Committee in May, has combined with Federal Reserve rate hikes to lift financial stocks worldwide. We believe, however, that it is time investors shifted their focus away from a deregulation-led valuation recovery to the industry polarization that capital leverage regulations will bring. Historically, when rules have tightened, better capitalized institutions have gained market share and acquired weaker players. JP Morgan is a case in point. After the 2008 financial crisis, the company took advantage of its capital strengths to supplant Citigroup as the world’s largest investment bank.

Banking indices: Korea, US, and Europe (2015-2017) Insurance indices: Korea, US, and Europe (2015-2017)

(Index: Dec 30, 2014 = 100) (Index: Dec 30, 2014 = 100)

140 130 130 120 120 110 110 100 100 90 90 80 70 80 60 Jan 15 Jul 15 Jan 16 Jul 16 Jan 17 Jan 15 Jul 15 Jan 16 Jul 16 Jan 17 KSE Insurance MSCI US Insurance KSE Banks MSCI US Banks MSCI EU Banks MSCI EU Insurance

Source: WiseFn, Bloomberg Source: WiseFn, Bloomberg

Financials

2017. 5. 29

Financial firms heavily regulated on capital The leveraging of capital is the key trait that sets financial service providers and manufacturers apart. In Korea, asset-to-equity ratios average 13.5x at banks, 10.1x at insurers, and 2.1x at manufacturers. High leverage entails high risk, and financial firms tend to be subjected to strict capital regulations as a result. Banks are governed by BIS capital rules, insurers by risk-based capital rules, and brokers by net capital rules, with standards applied in consideration of nation-specific factors.

Asset-to-equity ratios, by industry Capital regulations in Korea’s financial industry (x) Industry Key metric Authority Key ratio 16 Basel Committee BIS CAR = BIS capital / RWA 13.5 Banking BIS capital FSS CET-1 ratio = CET-1 capital / RWA 12 10.1 9.1 8.7 7.1 RBC ratio = Available capital / 8 Insurance RBC FSS required capital 4.0 4 2.1 Securities NCR = (net working capital – total NCR FSS brokerage risk) / required shareholder equity 0 Source: Samsung Securities

Banking Credit car Credit Insurance Brokerage Manufacturing Savings Banks Savings Specialty finance Specialty

Note: As of end-2016 Source: WiseFn

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2017. 5. 29

History of capital regulations: How to reduce systemic risk and stimulate economy Wary of excess but wanting to stimulate economic growth, governments constantly move between tightening and loosening capital regulations, with financial crises tending to serve as inflection points. Regulators tighten their grip when leverage becomes so excessive it triggers a crisis, but gradually pull back to increase liquidity in the market as an economic slump persists.

US In the US, Congress passed the Glass-Steagall Act in 1933 in response to the Great Depression, which was blamed on commercial banks using customer deposits for speculation. In 2010, the Dodd-Frank Act was established in the wake of the subprime debacle and global financial crisis. After time, however, both sets of regulations were relaxed in the interest of promoting financial sector and economic growth. Continuing a trend of deregulation that began in 1975 and expanded under the Bill Clinton administration, the Glass-Steagall Act was repealed in 1999 with the establishment of the Gramm-Leach-Bliley Act. Recently, the House of Representatives Financial Committee passed the Financial Choice Act 2.0, a move that helps fulfill Trump’s vow to scale back the Dodd-Frank act and aims to revitalize lending by commercial banks, grow small companies, and create jobs. Under the legislation, large banks will stress tested every two years (rather than one), the Volcker Rule—which prohibits use of assets for proprietary trading of high-risk instruments—will be repealed, and the Consumer Financial Protection Bureau’s power to make and enforce rules will be slashed. This marks a significant loosening of regulations introduced after the last financial crisis.

Korea Korea has also rotated between regulatory tightening and easing. In the wake of the International Monetary Fund bailout, a credit card bubble bursting, and the global financial crisis, financial firms were subjected to tougher capital regulations to prevent leverage from becoming systemic risk. Recapitalization has been taxpayer-funded, and the regulations were some of the world’s strictest. Once the nation has recovered, however, regulations have eased, because the role financial firms play in circulating funds has an enormous impact on the economy. Too much regulation on leverage can dampen lending, investments, and economic growth, so authorities eventually move to deregulate and encourage firms to help stimulate the economy. Banks were subjected to tighter Basel III rules and insurers to tighter RBC rules after the global financial crisis, but their ensuing attempts to deleverage came to be seen as exacerbating an economic slump, and the authorities responded by making it easier to recapitalize, allowing banks to count loan loss reserves as CET-1 capital and insurers to count subordinated bonds as capital.

Banks: Asset-to-equity ratios in the US Banks: Asset-to-equity ratios in Korea

(x) (x) Basel II Basel III 25 Gramm-Leach- Dodd-Frank Act 22 (2009) (2013) Bliley Act (1999) (2010)

20 18

15 14

10 10 5 2005 2007 2009 2011 2013 2015 1997 2000 2003 2006 2009 2012 2015 KB Kookmin Bank Shinhan Bank Citi JP Morgan BOA Wells Fargo KEB Hana Bank Woori Bank

Source: Bloomberg Source: FSS

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2017. 5. 29

Financial stocks recovering from long period of strict regulations Leverage regulations impact financial stock valuations because they alter: 1) return on assets by changing the businesses companies can operate in; and 2) degrees of leveraging, which help determine ROE. Financial companies derated while deleveraging to adjust to stricter regulations in the aftermath of the global financial crisis, but valuations have been recovering over the past year on rising interest rates and anticipation of laxer regulations under a Trump administration.

Deleveraging to meet capital requirements triggers derating As capital regulations tightened after the 2008 financial crisis, financial companies around the world saw their capital decrease due to massive losses incurred during the crisis, and a recession made it difficult to grow the profits needed to rebuild capital. To raise capital ratios, firms had to deleverage by reducing assets or increase capital via rights offerings. Asset reductions reduce earnings potential, and rights offerings dilute shareholder value—both factors hurt valuations. US financial companies derated after the crisis due to concerns over rights offerings and post-deleveraging ROE declines. Rights offering concerns: After the global financial crisis, concerns over rights offerings loomed large in the US as authorities stress tested banks based on tangible common equity (deducting preferred shares, intangible assets, and hybrid bonds from tier-1 capital, which was the typical basis for testing under the Basel II system). For banks to quickly boost capital ratios, they were expected to have to conduct rights offerings that would trigger a substantial dilution of shareholder value. Banks’ P/B multiples plunged to less than 1x as a result, with weakly capitalized banks hit hardest. Bank of America traded down to a bankrupt-like 0.11x P/B, and Citigroup dropped to 0.08x as the government increased its stake to 34% by converting USD25b of the USD45b worth of preferred shares it held in the company into common shares. Deleveraging worries: Banks also were not allowed to use shareholder equity or borrowings to invest in high-risk, high-return assets such as equities, bonds, and derivatives, and were forced to cut leverage ratios ahead of a full introduction of Basel III rules. Systemically important financial institutions—ie , “too big to fail”—bore the brunt of such regulations. As a result, US banks have yet to rebuild their proprietary trading earnings to 2010 levels despite a recovery in capital markets. Between 2008 and Feb 2016, their net interest margins fell to an average of 3.16%, their ROA from 1.2% to 1.94%, and their ROE from 11.44% to 9.34%. P/B multiples dropped from 2.09x to 0.85x.

US banks: End-2008 capital adequacy ratios (x) CET-1 TCE Goldman Sachs 15.6 4.9 Morgan Stanley 17.9 4.4 JP Morgan 10.9 3.8 BOA 9.2 2.8 Wells Fargo 7.8 2.3 Citigroup 11.9 1.6 Source: Bloomberg

US banks: 2009 stress tests (USDb) Tier-1 capital RWA Expected loss Required additional capital BOA 173.2 1633.8 136.6 33.9 Wells Fargo 86.4 1082.3 86.1 13.7 Citigroup 118.8 996.2 104.7 5.5 Morgan Stanley 47.2 310.6 19.7 1.8 JPMorgan Chase 136.2 1337.5 97.4 0.0 Goldman Sachs 55.9 444.8 17.8 0.0 Source: FRB, Bloomberg, BOK

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2017. 5. 29

US banks: Valuations before and after financial crisis US banks: Recapitalization details (USDb) When Method Amount (x) May 2009 Sold CCB stakes 7.3 3.5 Bank of 2.95 May 2009 Converted preferred stocks to common 6.5 3.0 America May 2009 Issued common stock 1.7 2.5 2.10 1.86 Citigroup Jun 2009 Converted preferred stocks to common 58.0 2.0 1.41 Wells Fargo May 2009 Issued common stock 7.5 1.5 Morgan Stanley May 2009 Issued common stock 8.0 1.0 0.50 0.44 Source: BOK, local media 0.5 0.08 0.11 0.0 Wells Fargo Citigroup BOA JP Morgan

Highest P/B (Aug 2006) Lowest P/B (Mar 2009)

Source: Bloomberg

US banks: Trading gains & losses vs NIM US banks: ROA vs net profit

(USDb) (%) (%) (USDb)

30 Global financial crisis 3.9 1.5 200 Global financial crisis 25 1.0 150 20 3.6 0.5 15 100 3.3 0.0 10 50 (0.5) 5 3.0 0 0 (1.0) (5) 2.7 (1.5) (50) 2005 2007 2009 2011 2013 2015 2005 2007 2009 2011 2013 2015

Trading gains & losses (LHS) NIM (RHS) ROA (LHS) Net profit (RHS)

Source: Bloomberg Source: Bloomberg

US banks: Asset-to-equity ratios vs LLRs/total assets US banks: ROE vs P/B

(x) (%) (%) (x) Global financial crisis 11.0 2.0 15 Global financial crisis 2.5

10.5 1.6 10 2.0 10.0 5 1.2 1.5 9.5 0 0.8 9.0 1.0 (5) 8.5 0.4 (10) 0.5 8.0 0.0 2005 2007 2009 2011 2013 2015 (15) 0.0 2005 2007 2009 2011 2013 2015 Asset-to-equity (LHS) ROE (LHS) P/B (RHS) Loan loss reserves / total assets (RHS)

Source: Bloomberg Source: Bloomberg

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2017. 5. 29

Valuations recovering as regulations ease As financial companies came into compliance with stricter regulations, however, valuations began recovering. Concerns over injections of public funds and shareholder value dilution (triggered by rights offerings) have eased, and firms have started re-leveraging, accumulating assets that lead to profit growth. By end-2009, US and Korean banking stocks had surged a respective 178% and 147% from their lows that year after stress tests on US banks concluded. Stocks have rallied strongly since 2H16, after dropping earlier last year amid concerns over rights offerings for Deutsche Bank in 1Q16 and for Italian banks in 2Q16. Concerns receded after European bank stress tests and a rights offering by Banca Monte DEI Paschi di Siena, while Fed rate hikes have boosted hopes for profitability gains, and the Trump administration has sought to ease regulations.

Banking indices: Korea, US, and Europe (2008-2017) Insurance indices: Korea, US, and Europe (2008-2017)

(Index: Dec 30, 2007 = 100) (Index: Dec 30, 2007 = 100)

120 140 100 120 100 80 80 60 60 40 40 20 20 2008 2010 2012 2014 2016 0 2008 2010 2012 2014 2016 KSE Insurance MSCI US Insurance KSE Banks MSCI US Banks MSCI EU Insurance

Source: WiseFn, Bloomberg Source: WiseFn, Bloomberg

Bank P/B: Korea, US, Europe Insurance P/B: Korea, US, Europe

(x) (x) 1.7 1.8 1.6 1.5 1.4 1.3 1.2 1.0 1.1 0.8 0.9 0.6 0.4 0.7 0.2 0.5 0.0 2012 2013 2014 2015 2016 2008 2009 2010 2011 2012 2013 2014 2015 2016 KSE Insurance MSCI US Insurance KSE Bank MSCI US Bank MSCI EU Bank MSCI EU Insurance

Source: WiseFn, Bloomberg Source: WiseFn, Bloomberg

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2017. 5. 29

Focus on gaps in fundamentals and valuations resulting from capital differences With the rally well underway, we advise focusing on financial players with the capital adequacy and execution capabilities required to lead change in the market landscape—firms with high capital ratios should be able to amass economies of scale through market-share gains and M&As, furthering their superiority in fundamentals over second-tier players and garnering higher valuations

More capital = more market share = economies of scale = better fundamentals Financial players that meet stricter capital requirements first tend to gain market share and bolster their fundamentals, particularly so in a mature market. Funding needs grow quickly in an economic recovery but price competition is usually weak because only a few institutions that have met capital- ratio requirements can expand assets. These firms tend to add quality customers, which gives them greater earnings capabilities. The US financial industry experienced such change after the 2008 financial crisis. While the well- capitalized Goldman Sachs and JP Morgan saw loans increase at respective CAGRs of 8% and 5.1% over 2010-2016, Citigroup could achieve only 0.6% growth and Bank of America posted a -0.4% figure because of low capital ratios. Faster asset growth means greater earnings power, and this was borne out: Pre-crisis (in 2006), JP Morgan earned 31.7% less than BOA, but by 2016, when credit costs stabilized, JP Morgan earned 42.5% more—and traded at 1.35x P/B, a 36.3% premium to BOA.

US banks: Loans vs GDP (growth) US banks: Loan growth vs NIS US banks: Asset growth (% y-y) (% y-y) (%) (% y-y) (% y-y) Loan growth 25 4 US GDP growth 15 3.8 (RHS) 15 (LHS) 20 3 15 10 3.6 10 2 10 5 1 5 3.4 5 0 0 (5) 0 (1) 3.2 0 (10) Loan growth NIS (15) (2) (RHS) (5) (LHS) 2009 2011 2013 2015 (3) 3.0 (5) JP Morgan BOA (4) (10) 2005 2008 2011 2014 2.8 (10) Wells Fargo Citigroup 2005 2008 2011 2014

Source: Bloomberg Source: Bloomberg Source: Bloomberg

US banks: Asset CAGRs US banks: Net profits (2006 vs 2016) US banks: Net profits (2009-2016)

(USDb) (USDb) (%) 30 8 30 7 6.5 25 25 20 6 20 5 15 15 4 10 3.0 10 3 5 2 5 0 (5) 1 (0.3) 0 (0.5) 2009 2011 2013 2015 0 JP Wells BOA Citigroup Morgan Fargo (1) JP Morgan BOA Wells JP BOA Citigroup Fargo Morgan 2006 2016 Wells Fargo Citigroup

Source: Bloomberg Source: Bloomberg Source: Bloomberg

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2017. 5. 29

US banks: Share performances (2007-2017) US banks: P/Bs (2007-2017)

(Index: Jan 3, 2007 = 100) (x) 250 3.0 2.5 200 2.0 150 1.5 1.0 100 0.5 50 0.0 2007 2009 2011 2013 2015 2017 0 2007 2009 2011 2013 2015 2017 JP Morgan BOA

JP Morgan BOA Wells Fargo Citigroup Wells Fargo Citigroup

Source: Bloomberg Source: Bloomberg

Capital strength gives top players the pick of the litter when it comes to M&As Divergence in fundamentals ultimately triggers M&As and wider gaps. Marginal players, their market share shrinking and profitability eroding, are put on the block; mid-tier players face growing pressure to close the gap with frontrunners; and top-tier firms with a solid capital base diversify and cement their dominance by cherry-picking M&A candidates. We saw this in the US in the 1990s and early 2000s—banks were the primary M&A players from the early 1990s and were joined by non- banks after the 1999 passage of the Gramm-Leach-Bliley Act removed barriers among banks, brokers, and insurers that prohibited any one from acting as any combination of an investment bank, commercial bank, and insurance company.

Early to mid-1990s: Mid-sized banks pursued M&As to make the jump to top-tier players in the early 1990s. In 1991 Chemical Bank (the sixth largest US bank in assets) merged with Manufacturers Hanover, and in 1992 NCNB (7th) and C&C/Sovran (8th) merged to create Nations Bank, the country’s fourth-largest bank.

Late 1990s to early 2000s: Brokers and insures got in the game in the late 1990s. Citigroup became the unrivaled leader in assets and profits through the 1998 mergers of Citicorp and Travelers Group, and rallied as its G&A cost ratio and profits improved on greater economies of scale and scope.

US banks: M&A history Year M&A details (US asset ranking in parentheses) Post-M&A ranking 1991 Chemical Bank (6th) acquires Manufacturers Hanover (10th) 3rd 1992 BOA (2nd) merges with Security Pacific (5th) 2nd 1992 NCNB (7th) and C&C/Sovran (8th) merge to create Nations Bank 4th 1995 First Union (9th) acquires First Fidelity (25th) 6th 1995 First Chicago and NBD Bancorp merge 8th 1995 Chemical (3rd) and Chase Manhattan (6th) merge 1st 1998 Wells Fargo (17th) and Norwest merge 7th 1998 BOA and Nations Bank merge n/a 1998 Citicorp acquires Travelers 1st 1998 Bank One and First Chicago merge 5th 2000 JP Morgan and Chase Manhattan merge 3rd 2004 BOA (3rd) and Fleet Boston (7th) merge 2nd 2004 JP Morgan Chase (3rd) and Bank One (6th) merge 3rd 2005 BOA acquires MBNA 2nd Source: Local media, Samsung Securities

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2017. 5. 29

Citigroup: Asset growth and costs Citigroup: Price vs relative return Citigroup: ROE vs P/B (% y-y) (%) (USD) (%) (%) (x) Travellers 30 6 600 acquisition 400 30 4.0 25 350 3.5 5 500 20 20 300 3.0 G&A costs/ 10 ROE (LHS) 15 4 400 Price total assets (LHS) 250 2.5 10 (RHS) 0 3 300 200 2.0 5 (10) 150 1.5 0 2 200 P/B Return (20) Asset 100 (RHS) 1.0 (5) relative to growth 1 100 (10) NYSE (RHS) 50 (30) 0.5 (LHS) (15) 0 0 0 (40) 0.0 1997 2001 2005 2009 2013 1995 1998 2001 2004 1997 2002 2007 2012

Source: Bloomberg Source: Bloomberg Source: Bloomberg

The global financial crisis sparked another wave of M&As, with sales and acquisitions of non-core assets and ailing players markedly altering rankings in the market. JP Morgan, which had some of the highest capital ratios in the industry before the crisis, became the world’s leading bank after acquiring Bear Stearns in Mar 2008 and Washington Mutual in Sep 2008. Citigroup, once the world’s second-largest bank, fell to seventh after selling its stake in Smith Barney to lift its capital ratios.

US banks: Structural changes after global financial crisis Banks (equity ranking*) Details - Acquired investment bank Bear Stearns (Mar 2008) and savings bank Washington Mutual (Sep 2008) JP Morgan Chase (3rd) - Created synergies between investment banking (JP Morgan) and commercial banking (Chase) - Acquired investment bank Merrill Lynch (Jan 2009) BOA (5th) - Transformed from commercial bank to global financial group (ranked first in equity at end-2011) - Forced to sell distressed assets ( eg , Citi Holdings) and non -core operations ( eg , Smith Barney in 2009) Citigroup (7th) - Global ranking fell from 2nd to 7th - Became banking holding company ( with IB -centered model) and sold off non -core assets ( eg, ICBC stake) Goldman Sachs (14th) - Expanded private banking business by acquiring Dwight Asset Management (Mar 2012) - Sold non -core assets ( eg , MSCI) and expanded wealth management business by acquiring Smith Barney (Jan 2009) Morgan Stanley (20th) - Expanded in Asia through joint ventures with Mitsubishi UFJ (Japan) and Huaxin Securities (China) Note: * Global ranking based on end-2014 equity Source: KDB

Recent M&As have largely involved smaller, regional banks because regulations do not allow leading players to expand further via M&As, and small players have turned to M&As to lift profitability in the face of low interest rates, structurally declining ROEs, and strict regulations. Huntington Bancshares bought FirstMerit for USD3.4b in Jan 2016, and First Horizon National and Capital Bank Financial merged in May 2017 to create the fourth largest regional bank in the southeast US.

US banks: Recent mergers have involved mostly smaller regional players Date Acquirer Acquired Deal (USDb) Nov 2010 PNC Financial RBC Bank USA 3.6 Mar 2012 BB&T BankAtlantic 0.3 Nov 2014 BB&T Susquehanna Bancshares 2.5 Aug 2015 BB&T National Penn Bancshares 1.8 Jan 2016 Huntington Bancshares FirstMerit 3.4 Jun 2016 People's United Financial Suffolk Bancorp 0.4 May 2017 First Horizon National. Capital Bank Financial. 2.2 Source: Bloomberg, press reports

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2017. 5. 29

Contents

All about leverage p2 Banks: Capital adequacy p11 already setting some apart Insurers : C oncerns over capital regulation tightening p30 can mount Securities Brokers: Business model differentiation Banks p47 underway to boost capital utilization efficiency Capital-related valuation discounts for domestic banks largely dissipated following the 2008 global Company p74 financial crisis. However, ahead of the full implementation of Basel III standards from 2019, gaps in CET-1 ratios are translating into widening gaps in both fundamentals and ability to engage in M&As.

We advise investors to focus on those banks that will generate stronger earnings thanks to their high capital-adequacy ratios, instead of looking simply for stocks trading at low valuation multiples.

Stricter post-crisis capital regulations led to rights offering at banks Banks conducted two rounds of rights offerings after the financial crisis. The first took place over 2008-2009 to help with deleveraging and provisioning. The second was led by regional financial groups over 2014-2015 in preparation for Basel III standards and to deal with profitability deterioration stemming from the Bank of Korea’s key-rate cuts. Such rights offering also addressed mounting concerns related to well-regarded overseas banks whose capital ratios were too low.

Post-crisis rights offerings aimed at addressing massive credit costs The main reason for the first round of rights offerings was the steep growth in assets. Though Korean banks posted loan growth of 10.5% pa over 2005-2008, their ROE slipped to a single-digit percentage over the same period (vs over 20% in 2005) and credit costs ballooned on increased exposure to sectors sensitive to economic cycles ( eg , construction, property project financing, shipbuilding, and shipping). Facing a severe global credit crunch, domestic banks conducted massive rights offering from the end of 2008. Out of the KRW20t state-run bank recapitalization fund, a total of KRW4t was utilized as supplementary capital by national banks. Major banks also issued new shares raise funds. SFG, for example, issued KRW1.3t worth of common shares (KRW16,800/share; 0.44x P/B) in Feb 2009, while KBFG issued KRW984b worth of shares in Jul 2009 (KRW37,250/share; 0.88x P/B).

Korean banks: Loan growth vs ROE Korean banks: P/B vs Tier-1 capital Korean banks: Tier-1 capital ratios ratio (%) (%) (x) (%) (%) 18 25 2.5 13 12 16 9.9 12 9.4 9.3 14 20 2.0 10 8.8 8.5 8.0 12 11 7.8 7.7 7.6 7.5 15 8 10 1.5 10 8 6 10 9 6 1.0 4 4 5 8 0.5 2 7 2 0 0 0.0 6 2004 2005 2006 2007 2008 0 2004 2005 2006 2007 2008 KEB Hana

Loan growth (LHS) Woori Busan P/B (LHS) Daegu Shinhan Jeonbuk Kwangju ROE (RHS) Kookmin Tier-1 ratio (RHS) Kyongnam

Source: FSS, Samsung Securities Source: BOK Note: As of end-2008 Source: FSS

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Korean banks: P/B lows over 2008-2009 Recapitalization fund overview Capital-injection methods (x) Fund purchased banks’ subordinate bonds (KRW10t) 0.50 0.46 0.46 Fund purchased banks’ hybrid securities (KRW8t) and preferred stock (KRW2t) 0.45 0.43 Funding methods 0.41 0.40 0.40 Lending from KDB (KRW12t) 0.33 0.35 Disposal of ABS backed by subordinate bonds (KRW8t) 0.32 (KRWb) Capital injections 0.30 0.28 0.24 WFG Woori Kyongna Kwangju Kookmin Hana NH SH Total 0.25 Bank m Bank Bank Bank Bank 0.20 Hybrid securities 0 1,000 116 87 1,000 400 750 100 3,453 Subordinate bonds 300 0 116 87 0 0 0 0 503 IBK KEB SFG HFG WFG KBFG

Busan Total 300 1,000 232 174 1,000 400 750 100 3,956 Daegu

Jeonbuk Source: FSC

Source: Samsung Securities

Korean banks: Right offerings over 2008-2009 (KRWb) Date Issued ownership Proceeds Offering details (%) Price/share (KRW) P/B (x) Discount (%) KBFG Jul 10, 2009 6.9 984 37,250 0.83 (20.7) SFG Fe 2, 2009 16.4 1,310 16,800 0.44 (36.5) Dec 18, 2008 8.5 500 7,355 0.48 (18.3) Jan 2, 2009 10.0 360 7,305 0.52 (5.6) IBK Jan 20, 2009 3.3 140 8,247 0.59 (5.7) May 14, 2009 6.4 300 8,642 0.65 (4.0) Busan Bank Jan 21, 2009 21.4 200 5,000 0.45 (16.0) Jeonbuk Bank Mar 6, 2009 14.6 40 5,000 0.65 19.2 Source: FSS, Samsung Securities

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2017. 5. 29

Regional players hold rights offerings ahead of Basel III and amid low rates, Europe risk Despite massive rights offerings, concerns about banks’ capital levels resurfaced for three reasons. First, many banks failed to meet the Basel III CET-1 ratio requirement of 10.5-11.5%. In Korea, the requirement is 11.5% for domestic systemically important banks (D-SIBs) and this includes a countercyclical capital buffer of 2.5%. Second, several BOK rate cuts slashed banks’ NIM and slowed their asset expansion. Third, cyclical sectors ( eg , shipbuilding and shipping) have been restructuring.

Basel III introduction schedule (%) 2013 2014 2015 2016 2017 2018 2019 Key indicators Minimum CET-1 ratio (A) 3.50 4.00 4.50 4.50 4.50 4.50 4.50 Tier 1 ratio 4.50 5.50 6.00 6.00 6.00 6.00 6.00 Minimum total capital ratio (C) 8.00 8.00 8.00 8.00 8.00 8.00 8.00 Conservation buffer (B) 0.625 1.25 1.875 2.50 Required total capital ratio (B+C) 8.00 8.00 8.00 8.625 9.25 9.875 10.5 Loss capital ratio (≥ 100%) 60 70 80 90 100 Net stable funding ratio (≥ 100%) Introduction Leverage ratio (Tier 1 capital/exposure ≥ 3%) Introduction Source: FSC

Korean banks: CET-1 ratios Korean banks: ROE vs BOK policy Shipbuilder/shipper restructuring rate Company Status Details Creditor Sold (%) (%) (%) Receivership subsidiaries STX O&S KDB 14 14 3.5 (May 2016) and laid off 12.6 12.5 10.5 60% of workers 12 11.1 12 3.0 Voluntary 10.4 No new orders 10 9.2 10 Sungdong restructuring 9.2 8.4 8.1 (expected to KEXIM 7.8 2.5 Shipbuilding (since Apr 8 8 close) 2.0 2010) 6 6 Closed Failed to sell SPPS Woori 4 4 1.5 (Mar 2017) assets SM Korea Receivership Acquired by 2 Hana 2 1.0 Line (Jan 2011) SM Group 0 2009 2011 2013 2015 Acquired by Receivership Pan Ocean Harim Group KDB IBK ROE(LHS) (Jun 2013)

Hana consortium Woori Busan Daegu Receivership Being Shinhan Jeonbuk Kwangju Kookmin Policy rate (RHS) HJS KDB (Aug 2016) liquidated Kyongnam Source: Local press, Samsung Securities Note: As of end-2013 Source: BOK, WiseFn Source: FSS

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2017. 5. 29

Concerns over capital levels were only encouraged by regional banks’ rights offerings and news that some European banks (such as Deutsche Bank) were struggling to recapitalize. Domestic banking shares slid to 0.26x P/B in Feb 2016. When Deutsche Bank shares tumbled amid the contingent convertible (CoCo) bond fiasco, HFG was the Korean bank hit hardest, due to its low CET-1 ratio.

Regional financial groups: Right offerings Korean banks vs HFG: P/Bs (KRWb) Date Issued ownership Proceeds Price /share (%) (KRW) (x) 1.2 DGBFG Nov 10, 2014 20.7 315 9,010 BNKFG, JBFG offerings JBFG Oct 13, 2015 15.7 182 6,300 Banks (Nov 2015 ) 1.0 BNKFG Nov 17, 2015 17.7 473 6,750 Deutsche DGBFG offering Bank Source: FSS 0.8 (Nov 2014) concerns (Feb 2016) 0.6 HFG 0.4

0.2 2010 2011 2012 2013 2014 2015 2016 2017

Source: Samsung Securities

Concerns over CET-1 ratios dissipate over past year Concerns over CET-1 ratios have eased significantly in the past year thanks to the possibility of such ratios improving via a decline in risk-weighted assets and the introduction of an internal ratings- based system (à la HFG’s), the inclusion of loan-loss reserves in common equity capital, and ROE recovering more quickly thanks to asset growth.

HFG’s CET-1 ratio shoots up HFG’s CET-1 ratio surged 60bps q-q to 10.38% in 1Q16 and then 97bps q-q to 11.35% in 2Q16, immediately dispelling concerns related to the firm’s rights offering and prompting shares to rally 4.6% the day after 1Q16 results were announced and 9.5% the day after 2Q16 results were announced. HFG has seen the biggest share-price increase of any Korean bank, jumping 117% since Jan 2016. Such remarkable progress is attributable to the firm: 1) lowering its risk-weighted assets and focusing on profitability; and 2) reducing its unused credit lines and large-enterprise credit lines; and 3) introducing an IRB system for its credit card operation. This has prompted many in the market to wonder whether other banks could lift their CET-1 ratios sharply by adopting similar strategies.

HFG: Large corporate loan trends HFG: Asset growth vs RWA growth HFG: P/B vs CET-1 ratio (%) (%) (%) (x) 2Q (%) 0.7 results 13 25 15 10 19.2 Asset growth 1Q 20 5 0.6 results 12 15.6 5 15 11.6 (5) 0.5 11 8.5 10 (15) 0 0.4 10 5 (25) 0.3 9 (5) 0 (35) 0.2 8 2013 2014 2015 2016 (10) 2014 2015 2016 2017 RWA growth Portion (LHS) P/B (LHS) (15) Growth (RHS) 2013 2014 2015 2016 CET-1 ratio (RHS)

Source: Company data Source: Company data Source: WiseFn

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2017. 5. 29

Loan-loss reserves recognized as capital Loan-loss reserve accounts were created during the 2011 switch to IFRS accounting that led to a plunge in banks’ provisioning balances (from levels recognized under the prior K-GAAP accounting method). Currently, Korea’s Financial Supervisory Service mandates that banks set aside the difference between IFRS-based provisioning and FSS requirements as ‘loan-loss reserves’ that are unavailable for dividend distribution. Since end-2016, the Financial Services Commission has allowed banks to count loan-loss reserves as common equity capital in order to alleviate the excessive burden of Basel III standards (which will take full effect in 2019) and help them compete on par with foreign banks. As a result, CET-1 ratios of Korea’s banks rose by an average of 135bps, and national banks that had recognized massive loan- loss reserves enjoyed the most dramatic improvements—eg , Woori Bank’s CET-1 ratio leapt 163bps q-q to 10.7% in 1Q17, reducing concerns over its capital ratio.

CET-1 ratio: Sensitivity to counting loan loss reserves as common equity capital (KRWb) Based on listed firms KBFG SFG HFG Woori Bank IBK BNKFG DGBFG JBFG Kwangju Bank Total CET-1 capital 29,932 25,900 21,001 16,088 14,997 6,264 3,478 2,326 1,283 121,269 Loan loss reserves 2,754 2,640 2,227 2,440 2,358 504 298 298 173 13,692 RWA 200,367 196,841 169,028 149,788 155,999 66,994 33,745 29,092 12,128 1,013,981 CET-1 ratio (%, excl LLR) 13.56 11.82 11.11 9.11 8.10 8.60 9.43 6.97 9.15 10.61 CET-1 ratio (%) 14.94 13.16 12.42 10.74 9.61 9.35 10.31 8.00 10.58 11.96 Effect of LLR (%pts) 1.37 1.34 1.32 1.63 1.51 0.75 0.88 1.02 1.43 1.35 (KRWb) Based on unlisted banking subsidiaries KB Kookmin Bank Shinhan Bank KEB Hana Bank Busan Bank Kyongnam Bank Daegu Bank Jeonbuk Bank Total CET-1 capital 23,147 20,303 21,252 4,243 2,589 3,123 1,020 68,931 Loan loss reserves 2,001 1,780 1,915 220 282 292 141 6,631 RWA 149,660 154,586 155,495 36,049 21,536 27,583 10,703 555,611 CET-1 ratio (%, excl LLR) 14.13 11.98 12.44 11.16 10.71 10.26 8.21 11.21 CET-1 ratio (%) 15.47 13.13 13.67 11.77 12.02 11.32 9.53 12.41 Effect of LLR (%pts) 1.34 1.15 1.23 0.61 1.31 1.06 1.32 1.19 Note: As of 1Q17; assumes all loan loss reserves are included in CET-1 calculation Source: Company data, Samsung Securities estimates

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2017. 5. 29

ROE rising on NIM recovery A rebound in market yields has also eased concerns over capital ratios. Lending rates at Korean banks are nowadays determined by a diverse array of yardsticks—eg , bank debentures and the Cost of Funds Index (Cofix)—rather than just the BOK’s key rate. So, even if the central bank keeps its policy rate unchanged, banks’ NIM could go up if domestic market yields rise. Indeed, market yields and the Cofix have trended up since September, and this has led banks’ NIM to rise from 4Q16. On average, NIM rose by around 5bps in 1Q17, helping ROEs recover.

New funds Cofix rate vs banks’ NIM Woori Bank: Household loan Woori Bank: Corporate loan breakdown, by rate benchmark breakdown, by rate benchmark (%) Deposit rate: 0.2% 4.0 Policy rate: 2.4% Deposit rate: 0.3% Policy rate: New funds Cofix 14.2% Fixed 3.5 Fixed rate: rate: 42.3% 20.3% 3.0 Floating Floating 2.5 rate loans: rate loans: 57.7% 79.7% 2.0 NIM CD rate: 1.5 Cofix: Other 21.8% 49.2% CD rate: 4.0% market rate: 1.0 43.5% 2012 2013 2014 2015 2016

Source: KFB, FSS Source: Company data Source: Company data

Korean banks: NIM (%) 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 1Q17 chg q-q (bps) KBFG 2.00 1.88 1.88 1.81 1.84 1.85 1.85 1.89 1.95 6 SFG 2.11 1.99 1.97 1.96 1.97 1.99 1.97 1.97 2.01 4 HFG 1.83 1.80 1.80 1.82 1.80 1.81 1.80 1.80 1.86 6 Woori Bank 1.87 1.84 1.81 1.85 1.87 1.85 1.87 1.83 1.91 8 IBK 1.91 1.91 1.92 1.91 1.91 1.91 1.90 1.91 1.92 1 Busan Bank 2.34 2.28 2.28 2.27 2.29 2.30 2.25 2.24 2.30 6 Kyongnam Bank 1.93 1.98 2.04 2.10 2.13 2.17 2.13 2.16 2.20 4 DGBFG 2.37 2.20 2.15 2.16 2.16 2.16 2.12 2.15 2.21 6 JBFG 2.29 2.29 2.27 2.24 2.22 2.25 2.23 2.16 2.19 3 Source: Company data

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2017. 5. 29

In 1Q17, banks’ ROE averaged 11.2%, but their risk-weighted assets this year should grow only 3-4% given that most banks’ are targeting loan growth of 4-5%. With the former far outpacing risk- weighted-asset growth, upticks in banks’ capital ratios are likely to accelerate.

Korean banks: ROE Korean banks: Loan growth vs RWA growth (%) 2012 2013 2014 2015 2016 1Q17* (%) KBFG 7.2 5.0 5.2 6.1 7.1 10.9 7 SFG 9.6 7.6 7.9 8.4 9.6 13.5 HFG 11.4 5.3 4.6 4.3 6.2 9.0 6 Woori Bank 8.8 2.9 7.9 7.0 8.1 15.8 5 IBK 9.2 6.4 6.8 7.6 7.3 10.7 4 Total loans BNKFG 11.6 9.0 19.6 9.3 8.3 10.5 3 DGBFG 10.8 9.1 8.2 9.2 8.0 9.8 2 JBFG 9.1 7.5 44.7 6.4 7.1 9.1 1 Note: * Annualized 0 Source: Company data RWA (1) 2012 2013 2014 2015 2016

Source: FSS

Korean banks: CET-1 ratio sensitivity to RWA growth and ROE (bps) RWA growth (%) 0 2 4 6 8 4 38 13 (10) (32) (54) 6 56 32 8 (15) (36) 8 75 50 26 3 (19)

ROE (%) (%) ROE 10 94 69 44 21 (2) 12 113 87 62 39 16 Note: Assumes dividend payout ratio of 25% Source: Samsung Securities estimates

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2017. 5. 29

Disparities in capital power to translate into stronger differences in fundamentals We believe investors need to focus on firms that can leverage higher capital ratios into differentiated profit growth. Commercial banks’ valuations have largely recovered as capital ratios have improved, but not regional financial holding companies—approval of their shift to an IRB method of calculating capital ratios (the timing of cannot be predicted) should determine their performance. Some worry about price competition resulting from asset growth, but we see this possibility as remote.

Most commercial banks already rerating on dissipation of capital concerns We believe shares in commercial banks have mostly reflected the easing of concerns over capital. Woori Bank and HFG (whose CET-1 ratios exceed 10% and 11%, respectively) have rallied a respective 117% and 96% from recent lows, sharply outperforming the sector’s gain of 57%. Meanwhile, regional financial groups have room to rerate as CET-1 ratios improve. The exception is DGBFG, which has climbed 58.8% from a Feb 2016 low as its CET-1 ratio has topped 10%. BNKFG and JBFG shares have risen an average of just 33% as their CET-1 ratios remain below 10%. That said, it should be some time before the dissipation of capital concerns at these banks leads to a further rerating. Compared to commercial banks, they have less exposure to the credit card business and loans to large corporations and thus been left with limited options to reduce risk-weighted assets. These banks could see their CET-1 ratios improve sharply as they shift to an IRB system. For example, we estimate that such a shift would boost BNKFG’s CET-1 ratio by 31bps.

Korean banks: Returns from Jan Korean banks: CET-1 ratios (1Q17) Korean banks: Large corporate and 2016 lows credit card portions of loans (1Q17) (%) (%) (%) 140 16 25 120 20 14 100 15 12 80 10 Average: 60 Average: 10 10.5 5 40 56.7% 8 0 20 IBK SFG HFG JBFG Woori 0 6 KBFG BNKFG DGBFG IBK IBK SFG HFG SFG HFG JBFG Woori KBFG JBFG Woori KBFG Large corporate Credit card BNKFG DGBFG BNKFG DGBFG

Source: WiseFn Source: Company data Source: Company data

Korean banks: How capital ratios are calculated Korean banks: IRB impact on capital ratio

IRB approach (Bps) Impact KBFG, SFG, HFG, Woori Bank, IBK, Kwangju Bank BNKFG 31 Standard approach DGBFG 40 Based on on Based listed firms firms listed BNKFG, DGBFG, JBFG Busan Bank 30 IRB approach Source: Company data KB Kookmin Bank, Shinhan Bank, KEB Hana Bank, Kyongnam Bank, Daegu Bank

unlisted unlisted Standard approach banking banking Based on on Based subsidiaries subsidiaries Busan Bank, Jeonbuk Bank Source: Company data

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2017. 5. 29

Differentiation in growth and capital power key We thus focus more on banks able to show differentiated growth on the back of stronger capital power, as growing assets via higher market shares brings on differentiated earnings by boosting interest income. For example, Shinhan Financial Group saw loan growth of 10.5% in 2015 (vs a sector average of 7.8%), which boosted its 2016 interest income by 8.1% y-y to KRW339b. Banks have already begun to show differentiated growth on rising CET-1 ratios, as: 1) it should not be long before Basel III is fully adopted in 2019; and 2) CET-1 ratio gaps are still wide. For example, banks with higher CET-1 ratios enjoyed stronger loan growth last year than those with low capital ratios. Banks with high capital ratios—KBFG, SFG, and HFG: We believe KBFG is best positioned to win market share, followed by SFG and HFG in that order. KBFG’s CET-1 ratio is 14.94%, SFG’s is 13.20%, and HFG’s is 12.42%—all far above the minimum requirement of 11.5% for D-SIBs (assuming a countercyclical capital buffer of 2.5%). Banks with low capital ratios: Meanwhile, as banks with low capital ratios are likely to focus more on raising their CET-1 ratios than on boosting market share, they are likely to raise their low risk-weighted loans and reduce their high risk-weighted loans. This should eventually lead to relatively low loan growth. Capital ratios are not the sole determinant of banks’ loan growth. Even if capital ratios are high, banks can be less aggressive in growing domestic loans, due to concerns over the credit cost cycle or overseas penetration. In contrast, even if capital ratios are low, banks might aggressively raise exposure to low risk-weighted mortgages. Banks that are more competitive in terms of capital power should have greater strategic choice than those that are not, and thus they are likely to be more able to differentiate themselves in terms of fundamentals when the market environment changes.

Korean banks: CET-1 ratios vs loan growth Korean banks: Loan growth and interest income (KRWb) Loan growth (%) 2016 interest income Loan growth (%) 2015 2016 Interest Chg Chg As % of pre-

7.0 income (y-y) (% y-y) tax income BNKFG 6.5 KBFG 5.6 6.4 4,829 117.2 2.5 9.3 KBFG 6.0 IBK SFG 10.5 4.4 4,504 339.0 8.1 16.7 5.5 HFG 3.6 4.1 4,642 103.2 2.3 5.7 Woori Bank 11.0 3.8 5,020 258.0 5.4 16.6 5.0 DGBFG IBK 7.6 6.2 4,883 252.0 5.4 16.6 4.5 SFG BNKFG 6.2 6.5 1,937 114.0 6.3 16.5 4.0 HFG 3.5 DGBFG 10.5 4.5 1,015 31.0 3.2 9.2 Woori Bank 3.0 JBFG 15.9 18.1 836 88.0 11.8 44.0 8.0 10.0 12.0 14.0 16.0 Total 7.8 5.4 27,666 1,302.4 4.9 13.8 CET-1 ratio (%) Note: All figures based on banking subsidiaries except for HFG Source: Company data, Samsung Securities Note: As of end-2016 Source: Company data

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2017. 5. 29

Price competition unlikely Some have argued that more aggressive asset growth might trigger lending-rate competition, leading to NIM declines. For example, banks’ loans increased at a robust 15.5% CAGR over 2006-2007, but price competition spread to deposit and lending rates. As a result, the average NIM fell around 15bps each year and interest income grew little. With loan growth potential down significantly now, concerns that NIM erosion will lead to a decline in interest income have been growing. We, however, do not expect to see price competition for the time being, as: 1) banks other than the top-three financial groups have sufficient incentive to control the pace of growth, as their CET-1 ratios remain below 11%; 2) Industrial Bank of Korea—which leads the SME lending market, where price competition is most likely—and regional banks have yet to improve CET-1 ratios enough compete aggressively; and 3) some large banks have seen three years of robust loan growth, and any price competition would likely bring their focus back to profitability rather than growth.

Korean banks: Loan growth and interest income (KRWb) Loan growth (%) NIM chg (bps) Interest income Chg (% y-y) 2006 2007 2006 2007 2006 2007 2006 2007 KBFG 5.9 16.5 (21) (28) 6,778 6,962 1.8 2.7 SFG 7.6 18.3 18 10 3,341 3,719 (8.0) 11.3 HFG 7.6 18.3 (2) (9) 2,328 2,524 16.6 8.4 Woori Bank 32.1 16.5 (36) (16) 3,500 4,142 10.9 18.3 IBK 22.7 14.9 (31) (13) 2,531 2,841 9.1 12.3 Busan Bank 21.5 17.1 (26) (1) 617 708 4.2 14.7 Kyongnam Bank 18.9 24.9 (22) (34) 392 412 4.0 5.1 Daegu Bank 15.4 15.0 (9) (37) 700 687 5.0 (1.8) Jeonbuk bank 13.8 14.0 (3) (20) 154 161 12.4 4.4 Total 14.1 17.0 (15) (16) 20,341 22,156 4.1 8.9 Source: Company data

Korean banks: SME lending market share Banks Market share (%) IBK 21.9 KB Kookmin Bank 13.2 Shinhan Bank 11.8 NH Bank 11.0 Woori Bank 10.9 KEB Hana Bank 10.5 KDB 4.1 Busan Bank 3.7 Daegu Bank 3.4 41% Kyongnam Bank 2.7 SH Bank 2.1 Kwangju Bank 1.4 Jeonbuk Bank 1.0 Citi Bank 0.9 SC Bank 0.7 Jeju Bank 0.4 KEXIM 0.3 Note: Based on end-2016 SME loans Source: FSS

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2017. 5. 29

Using excess capital for M&As key to rerating The history of Korea’s financial industry, especially the banking sector, is one of M&As. SFG became a leading bank in the 2000s by acquiring Chohung Bank and LG Card, while KBFG’s recent rerating was propelled by mega-deals with LIG Insurance and Hyundai Securities. Large groups are likely to keep looking for M&As, which should increase as the industry polarizes around capital adequacy..

Success in mega-M&As key to becoming Korea’s leading bank Since the mid-2000s, when banking-industry growth began to slow sharply, mega-M&As have been key to becoming a leading bank. In the face of tightening capital regulations—eg , the introduction of Basel II (SFG) and Basel III (KBFG)—the firms making the leap were ones that made bold bets based on superior capital adequacy and quickly turned acquisitions into full subsidiaries to enhance ROE.

Market cap: KBFG vs SFG

(KRWt) SFG: LG Card KBFG: 35 SFG: Goodmorning acquisition KBFG: Hyundai Securities acquisition Woori Financial Securities 30 acquisition acquisition 25 SFG: Cho Hung Bank acquisition 20 KBFG 15

10 KBFG: LIG Insurance 5 acquisition SFG 0 2002 2004 2006 2008 2010 2012 2014 2016

Source: WiseFn, Company data

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2017. 5. 29

SFG leads the pack after acquiring Chohung Bank and LG Card SFG began to grow rapidly in the mid-2000s via a series of M&As, including takeovers of Good Morning Securities in 2002, Chohung Bank in 2003, and LG Card in 2007. As a result, between 2004 and 2014, SFG’s total assets grew 130% to KRW33.8t, its share of the bank loan market jumped from 9.6% to 19%, and its non-banking profits soared from KRW11.8b to KRW923.7b. SFG’s improved fundamentals were tested and found to be sound during the global financial crisis. Through M&As with non-banking entities, SFG had achieved both economies of scale and scope, which granted it earnings growth and stability. Its well-diversified revenue streams (in which non- banking operations contributed 38.7% of profits as of 2014) allowed SFG to deliver the most-stable earnings performance during the global financial crisis. Between 2004 and 2014, its market cap leapt from KRW7.2t to KRW21.1t, and it sported the highest valuation among Korean banking stocks.

SFG: M&A history Date Details Aug. 2002 Acquires Good Morning Shinhan Securities Aug 2003 Acquires 80.04% of Chohung Bank Sep 2005 Acquires Shinhan Life Insurance Apr 2006 Shinhan Bank and Chohung Bank integrated Mar 2007 Acquires LG Card Jan 2010 Acquires Shinhan Data System Jan 2013 Shinhan Savings Bank merges with Yehanbyoul Savings Bank Source: Company data

SFG: Non-banking profits SFG vs KBFG: Net profit (2002-2014) (KRWt) (KRWt) (%) 3.5 LG Card acquisition 2.0 80 (Feb. 2007) 3.0 70 2.5 1.6 Non-banking profit (LHS) Cho Hung Bank SFG 60 acquisition 2.0 (Mar. 2003) 1.2 50 1.5 40 1.0 KBFG 0.8 30 0.5 Consolidated SFG 20 0.0 0.4 contribtuion (RHS) 10 (0.5) 0.0 0 (1.0) 2008 2010 2012 2014 2016 2002 2004 2006 2008 2010 2012 2014

Source: Company data Source: Company data

KBFG rerating on drive to use excess capital KBFG has effected remarkable changes over the past 2-3 years. Frequent management changes, the appointment of a chairman from outside the company, and a resulting lack of management consistency were often cited as the biggest factors eroding the company’s fundamentals. But in late 2014, Yoon Jong-Kyu became the first KBFG chairman hired from within, and he successfully transformed the company. Based on its overwhelmingly superior capital adequacy, KBFG: 1) acquired Hyundai Securities in 2016 and turned it into a wholly-owned subsidiary; 2) acquired LIG Insurance in 2015 and is taking steps to secure full ownership by July; and 3) is turning KB Capital— formerly Woori Financial—into a fully owned subsidiary after acquiring it in 2014.

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2017. 5. 29

KBFG also achieved qualitative improvements in management capability. Each of its non-banking affiliates posted steep profit improvement and, in less than a year, the big-three subsidiaries will be wholly owned—something unimagined in the past. Once its non-banking M&As are complete, KBFG should enjoy stronger, more stable earnings and rerate. Specifically, full ownership of KB Insurance and KB Capital will lift annual net profits to around KRW3t (vs KRW0.4t in 2014); economies of scope across non-banking businesses will allow greater synergies; and non-banking units will contribute 35% of the group’s earnings.

KBFG: M&A history Date Details May 2013 Acquires Yehansol Savings Bank May 2013 Acquires Yehansol Savings Bank Mar 2014 Acquires Woori Financial (renamed KB Capital) Jun 2015 Acquires LIG Insurance Source: Company data

KBFG: Non-banking profits KBFG vs SFG: Net profit (2012-2017)

(KRWb) Consolidated (%) (KRWt) KBFG contribution 700 40 (RHS) 3.0 600 Non- 35 banking 2.6 30 Acquired Acquired 500 profit SFG Woori Financial Hyundai Securities (LHS) 25 400 2.2 Acquired 20 LIG Insurance 300 1.8 KBFG 15 Jong Kyu Yoon Woori LIG Hyundai 200 named CEO Financial Insurance Securities 10 acquisition acquisition acquisition 1.4 100 (Mar 2014) (Jun 2015) (Mar 2016) 5 0 0 1.0 2012 2013 2014 2015 2016 2012 2013 2014 2015 2016

Source: Company data Source: Company data

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2017. 5. 29

Room for more M&As, further rerating We believe bank-centric financial holding groups will continue to pursue M&As with non-banking entities in an attempt to upgrade their fundamentals. In a low-growth, low-interest-rate environment, financial groups need to provide comprehensive financial services if they are to build customer loyalty and boost profitability. Still, most financial groups’ non-banking operations depend heavily on a few affiliates (notably credit card companies). Even if they have affiliates across all segments of the financial sector, those affiliates tend to be small compared to the group as a whole, which limits the potential for intra-group synergies.

Life insurance the final piece of the puzzle for KBFG Despite having a well-diversified profit structure, KBFG is likely to acquire another life insurer. Its major non-banking affiliates—KB Card, KB Securities, KB Insurance, and KB Capital—all have leading market positions and contribute decent profits of KRW103b-317.1b. KB Life, however, ranks 16th in the life insurance sector by assets (KRW8.9t) and generates miniscule annual net profits (KRW12.7b in 2016). Given that the life insurance market has already entered a low-growth, low- profit phase, KBFG is likely to pursue M&A-driven growth.

KBFG: Assets and profits, by subsidiary (KRWb) Total assets Asset Net profit Contribution to KBFG (KRWt) ranking* Consolidated net profit Portion of total (%) KB Kookmin Bank 307.1 3rd 964.3 964.3 65.5 KB Kookmin Card 15.8 3rd 317.1 317.1 21.5 KB Insurance 29.4 4th 295.8 117.7 8.0 KB Asset Management 0.2 4th 58.8 58.8 4.0 KB Capital 7.4 2nd 96.8 48.4 3.3 KB Life Insurance 8.9 17th 12.7 12.7 0.9 KB Savings Bank 1.1 14th 10.3 10.3 0.7 KB Securities** 32.4 5th (93.4) (93.4) (6.3) Note: As of end-2016 * Within respective industries ** Losses due to costs of integrating with Hyundai Securities Source: FSS

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2017. 5. 29

Aggressive use of capital accumulated over past decade is key for SFG SFG is likely to pursue M&As with non-banks. While it has a well-diversified profit structure, with 34.8% of profits coming from non-banking operations (as of 2016), 68.5% of its non-banking profits come from Shinhan Card. Looking at other non-banking affiliates: 1) Shinhan Life last year posted a net profit of KRW150.6b, which leaves room for improvement; 2) Shinhan Investment Corp, despite a rights offering that brought in KRW0.5t last year, has capital of KRW3t, leaving it short of the KRW4t mega-broker threshold; 3) Shinhan Capital has limited growth potential because of its B2B focus on ship financing; and 4) SFG does not have a non-life insurance license. Whether it is aggressive in its use of the capital it has accumulated over the past decade is now key. When acquiring Chohung Bank and LG Card, SFG issued corporate bonds, a move that limited room for further M&As. But now that its CET-1 capital and CET-1 ratio have improved to KRW26t and 13.2%, respectively, as of 1Q, it can afford to pursue large M&As. SFG is most likely to consider acquiring a life insurer, given that: 1) the addition of even a mid-sized player would be enough to achieve economies of scale, with Shinhan Life already controlling 3.5% of the domestic market; 2) the life insurance business, by nature, offers highly stable earnings; and 3) SFG has a good understanding of the industry, as seen in Shinhan Life’s quickly rising market share.

SFG: Assets and profits, by subsidiary (KRWb) Total assets (KRWt) Asset ranking* Net profit** Contribution to SFG earnings (%) Shinhan Bank 302.9 4th 1,940.3 64.6 Shinhan Card 24.4 1st 715.9 23.8 Shinhan Life Insurance 27.5 7th 150.6 5.0 Shinhan Investment 43.3 6th 115.4 3.8 Shinhan Capital 4.5 10th 33.9 1.1 Jeju Bank 5.2 12th 17.3 0.6 Shinhan Savings Bank 1.0 16th 12.5 0.4 Shinhan BNPP AM 39.4 5th 9.3 0.3 Note: As of end-2016 * Within respective industries ** Contributed to SFG’s consolidated earnings Source: FSS

Korean banks: Estimated limits for investing in subsidiaries (KRWt) Common equity CET-1 ratio Double leverage Additional investment limit capital (%) ratio (%) (2017E, under 140% double leverage ratio) KBFG 29,014 14.2 118.0 7,113 SFG 25,325 12.7 127.1 5,508 HFG 20,437 11.8 126.7 3,857 BNKFG 6,122 9.2 122.5 1,465 DGBFG 3,392 10.2 108.8 1,141 JBFG 2,326 7.9 127.0 418 Note: As of end-2016 Source: FSS, Company data

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Shinhan Life: Market share* vs net profit Life insurance: Market shares, total assets, and profits (KRWb) (%) (KRWb) Market share (%)* Total assets Net profit 200 4.0 Samsung Life Insurance 30.9 241.9 572.5 Hanwha Life Insurance 13.5 105.3 315.1 160 3.5 Kyobo Life Insurance 11.7 91.7 481.2 120 3.0 NH Life Insurance 7.9 61.7 151.5 Mirae Asset Life Insurance 3.6 28.3 37.2 80 2.5 Shinhan Life Insurance 3.5 27.5 150.1 Dongyang Life Insurance 3.4 26.7 5.4 40 2.0 Heungkuk Life Insurance 3.3 25.6 35.4 0 1.5 Note: As of end-2016 2005 2008 2011 2014 * Based on total assets Net profit (LHS) Source: FSS M/S (RHS)

Note: * Based on total assets Source: FSS

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HFG not quite ready HFG cannot as easily afford M&As, given that it: 1) must still improve its CET-1 capital and CET-1 ratio, which stand at KRW21t and 12.4%, respectively; 2) needs to lower its double leverage ratio, which remains at 126.7% despite improving following the KEB takeover; and 3) has yet to finish its organizational integration of Hana Bank and KEB. After enhancing its capital adequacy and completing the abovementioned integration, HFG is likely to pursue M&As with fervor, as: 1) only 16.7% of its profits came from non-banking operations in 2016; 2) profits at Hana Financial Investment, the biggest earnings contributor among its non- banking affiliates, fluctuate widely according to macro factors; and 3) Hana Life generated a net profit of just KRW16.6b last year. HFG more than any other financial group should have a taste for M&As given that Hana Bank was founded as a standalone bank and successfully grew into HFG through acquisitions of Boram Bank, Seoul Bank, Daehan Investment & Securities, and KEB.

HFG: Assets and profits, by subsidiary (KRWb) Total assets (KRWt) Asset ranking * Net profit** Contribution to HFG earnings (%) KEB Hana Bank 310.8 1st 1372.8 83.3 Hana Financial Investment 18.8 7th 86.5 5.3 Hana Capital 5.3 6th 75.5 4.6 Hana Card 7.1 7th 80.7 4.9 Hana Life 4.1 21th 16.6 1.0 Hana Savings Bank 1.2 12th 15.4 0.9 Note: As of end-2016 * Within respective industries ** Contributed to HFG’s consolidated earnings Source: FSS

HFG: Total assets and profit

(KRWt) Acquired KEB (KRWt) (Feb 2012) 400 1.8 Acquired Daetoo Securities 1.6 350 (May 2005) 1.4 300 Acquired Boram Net profit Bank (Jan 1999) Acquired (RHS) 1.2 250 Seoul Bank (Dec 2002) 1.0 200 Acquired Chung cheong Bank 0.8 150 (Jun 1998) 0.6 100 0.4 Total assets 50 (LHS) 0.2 0 0.0 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015

Source: WiseFn, Company data

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2017. 5. 29

Attractive M&A targets to come eventually That said, bank-centric financial holding groups are unlikely to engage in M&As soon. Achieving economies of scale requires big deals, but there are no large non-banking firms for sale now. In time, however, there should be, as: 1) IFRS 17, new RBC rules, and greater business scope for mega- brokers will further polarize the financial industry according to capital adequacy; 2) in a structurally low growth phase, companies failing to achieve scale should continue to lose market share and profitability, to the point that their status as a going concerns could be jeopardized; and 3) a rise in market interest rates will erode capital ratios at some insurers, necessitating recapitalization.

Life insurers: Key indicators (as of end-2016) (KRWb) Total assets Asset ranking Market share (%) * Net profit Market cap RBC ratio (%) Major shareholder (stake) Samsung Life 241,904 1 30.9 2,054.3 23,900 302.1 Kun-Hee Lee (47.0%) Hanwha Life 105,331 2 13.5 795.3 5,689 198.7 Hanwha Construction (48.3%) Kyobo Life 91,673 3 11.7 514.5 n/a 233.9 Chang-Jae Shin (40.3%) NH Life 61,701 4 7.9 154.5 n/a 186.5 NHFG (100.0%) ING Life 30,669 5 3.9 240.7 2,542 319.2 Life Investment LLC (59.2%) Mirae Asset Life 28,317 6 3.6 91.0 752 221.0 Mirae Asset Daewoo (46.2%) Shinhan Life 27,501 7 3.5 150.6 n/a 178.3 SFG (100.0%) Dongyang Life 26,666 8 3.4 12.0 1,604 182.0 Anbang Life (42.0%) Heungkuk Life 25,612 9 3.3 55.4 n/a 145.4 Ho-jin Lee (56.3%) MetLife 18,560 10 2.4 78.4 n/a 167.2 Metropolitan Global Management (85.4%) Note: * Based on total assets Source: FSS, company data

Securities brokers: Key indicators (as of end-1Q17) (KRWb) Total assets Asset ranking Net profit (2016) Market cap NCR (%) Major shareholder (stake) Mirae Asset Daewoo 6,661 1 27.8 6,437 2,391.5 Mirae Asset Capital (19.0%) NH I&S 4,615 2 211.1 3,996 1,341.9 NHFG (49.1%) KB Securities 4,183 3 (0.3) n/a 1,471.7 KBFG (100.0%) Samsung Securities 4,168 4 163.3 3,429 1,601.1 Samsung Life (30.4%) KIS 4,105 5 243.7 n/a 1,602.6 Korea Investment Holdings (100.0%) Shinhan Investment 3,100 6 123.3 n/a 938.1 SFG (100.0%) Hana Financial Investment 1,889 7 76.5 n/a 813.3 HFG (100.0%) Meritz Securities 1,887 8 253.0 2,683 690.2 Meritz Financial Group (33.8%) Daishin Securities 1,763 9 30.6 650 423.9 Hong-Suk Yang (11.2%) Kiwoom Securities 1,283 10 140.5 1,825 397.9 Daou Tech (47.9%) Source: FSS, company data

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2017. 5. 29

KBFG our top pick KBFG is our top pick for its stable earnings and upside arising from changes in its structure. The company is the sector’s best-capitalized, has a bright outlook after an aggressive voluntary retirement program implemented last year, and non-banking operations are contributing more to earnings. We expect KBFG’s non-banking profits to grow—eg , KB Insurance has seen earnings grow quickly on improvements in underwriting conditions; KB Capital should benefit from growth in a joint venture with Ssangyong Motor; and KB Securities should enjoy better earnings power via expansions into new businesses (on the back of capital exceeding KRW4t) and synergies with Kookmin Bank. Raising its stakes in non-banking affiliates should also amplify their impact on consolidated earnings. The group will soon acquire remaining shares in KB Insurance and KB Capital, which will start to contribute to consolidated earnings from 3Q17. In short, the full consolidation of the firms should not only boost KBFG’s capital but also generate KRW300b more in annual recurring earnings.

KBFG: Net profits of non-banking subsidiaries (KRWb) 2011 2012 2013 2014 2015 2016E 2017E KB Securities 136.7 (67.1) (42.9) 37.4 279.6 (166.8) 250.0 KB Insurance 209.0 164.4 118.4 138.7 173.7 301.2 354.4 KB Capital 53.7 54.1 32.6 63.1 95.7 96.7 111.1 Total 399.4 151.4 108.1 239.2 549.0 231.1 715.5 Source: Samsung Securities estimates

KBFG: Impact of acquiring all of KB Insurance, KB Capital KBFG: Cross-selling auto financing (KRWb) Affiliate Product Details 2017E net profit (current forecast) 2,708.0 KB Kookmin KB Magic-car Installment Contract period tailored to buyer’s plan KB Insurance 2017E net profit 354.0 Bank Savings Plan One account per person KB Additional net profit if fully owned 213.1 KB Magic-car Insurance Auto insurance Insurance KB Capital 2017E net profit 111.0 10% discount on monthly auto insurance KB Kookmin Additional net profit if fully owned 53.3 KB Magic-car premiums (KRW30,000 max) Card Tender offer financing 25.2 Varying discounts when buying gas Total payment 1,359.4 Customers using KB Kookmin Card to pay KB Capital Auto KB Capital auto -financing bills receive rate Cost of debt (3-year bank debentures) 1.9 Capital Installment Financing 2017E net profit (assuming 100% ownership of subsidiaries) 2,951.1 of 3.5 -4.2% (4.5% otherwise) Source: Samsung Securities Change relative to current forecast (%) 8.9 Changes in ROE (%pts) 0.7 Old ROE (%) 8.3 New ROE (%) 9.0 Old P/E (x) 7.4 New P/E (x) 6.8 Note: As of May 24 close; Source: Company data, Samsung Securities

KBFG: Tender offer details KBFG: Estimated negative goodwill KB Insurance KB Capital (KRWb)

Offer price (KRW) 33,000 27,500 Number of shares 36,237,649 Number of shares to be bought 40,027,241 10,311,498 Purchasing price per share (KRW) 33,000 Tender offer period Apr 17-May 12 2016 BVPS (KRW) 36,804 Payment date May 19 Negative goodwill 137.8 Date of consolidation May 19 Source: Company data, Samsung Securities estimates Source: Company data

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2017. 5. 29

Contents

All about leverage p2 Banks: Capital adequacy p11 already setting some apart Insurers : C oncerns over capital regulation tightening p30 can mount Securities Brokers: Business model differentiation Insurers p47 underway to boost capital utilization efficiency Although concerns over insurers’ capital adequacy have persisted since 2010, the key issues have Company p74 varied, with issues regarding capital power over the past five years have centered on life insurers since their liabilities have longer durations than those of non-life players, especially top-tier players, due to a high fixed-rate portion of liabilities. Worries now center on the 2021 introduction of IFRS 17, as it was originally to include mark-to-market accounting of liabilities, which some had expected to cause liabilities to surge and capital to plunge. Recent regulatory easing has largely eased such concerns, however, so RBC ratio declines-stemming from long-awaited market yield hikes and regulatory changes (K-ICS) have become more worrisome for insurers.

IFRS 17 regulatory concerns easing IFRS 17 originally required mark-to-market accounting of liabilities, but this caused capital- reduction concerns, as: 1) profits from existing contracts—ie , contractual service margin [CSM]— were to be booked as a liability; and 2) losses from such contracts would add to liability. With effects of the newly-revised standards not yet known, it is difficult to accurately calculate the: 1) value of CSM; and 2) amount of added liability—although by using reported LAT figures, rough calculations are possible. For instance, Samsung Life’s LAT deficit was KRW26.9t at end-1H16, nearly equal to its capital of KRW28.4t, and while true that if its LAT surpluses exceed deficits, the firm’s capital could actually rise, but this is impossible under IFRS phase II (as it prohibits netting LAT deficits and surpluses).

LAT LAT deficit impact on RBC ratios

(%) (%) 10 LAT net surplus/ 400 reserves 5 300 221.0 304.0 RBC

0 200 253.0 200.4 (5) 100 LAT net deficit/ 124.7 (10) reserves 64.7 0 RBC after (15) 25.8 (14.0) LAT deficit (100) (20) Samsung Life Hanwha Life Mirae Asset Tong Yang Samsung Life Hanwha Life Mirae Asset Tong Yang Life Life* Life Life* Note: As of end-2016 Note: As of end-2016 Source: Company data Source: Company data

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2017. 5. 29

The sheer size of LAT deficits is worrisome, but even more problematic under IFRS 4 is the possibility of: 1) related growth outpacing surpluses; 2) the discount rate—used to calculate surpluses and deficits—being lowered; and 3) LAT calculation assumptions becoming highly volatile. Our estimates show that Allianz Life was the only Korean insurer with a net LAT deficit at end-2015, and despite some market watchers saying it was a fire sale when the firm was bought for just KRW3.5b last year, this seems disproven by its LAT.

Surpluses and deficits, by product (KRWb) Samsung Life Hanwha Tong Yang Samsung F&M Hyundai Dongbu Meritz 2014 surplus (deficit) Participating (15,006) (5,191) (1,006) (46) - - 4 Fixed-rate Non-participating (6,828) (282) 428 (298) - - 1,346 Participating (666) (228) (13) 64 - - (2) Interest-rate linked Non-participating 21,088 4,790 592 6,927 - - 40 Variable insurance 8,123 2,880 463 - - - - Sum of surpluses 29,211 7,670 1,482 6,990 4,542 5,532 1,390 Sum of deficits (22,501) (5,701) (1,019) (344) (322) (482) (2) Total 6,711 1,969 464 6,646 4,220 5,050 1,387 2015 surplus (deficit) Participating (19,224) (6,793) (1,099) (353) - (129) (7) Fixed-rate Non-participating (6,928) (2,972) 307 6,663 - 100 48 Participating (950) (307) (21) (51) - (2) 8 Interest rate linked Non-participating 22,053 6,669 730 3 - 1,754 2,237 Variable insurance 9,608 4,587 498 - 67 Sum of surpluses 31,662 11,256 1,535 6,665 5,571 1,854 2,359 Sum of deficits (27,103) (10,072) (1,120) (403) (385) (131) (7) Total 4,559 1,184 415 6,262 5,186 1,723 2,352 2016 surplus (deficit) Participating (19,541) (6,864) (1,123) (59) (408) (86) (7) Fixed-rate Non-participating (6,524) (2,924) 474 (503) (182) (28) 66 Participating (831) (300) (14) 65 32 95 7 Interest rate linked Non-participating 22,719 6,912 875 7,443 6,606 7,415 2,686 Variable insurance 9,799 4,542 506 - - - - Sum of surpluses 32,518 11,454 1,856 7,507 6,638 7,510 2,759 Sum of deficits (26,896) (10,088) (1,137) (562) (590) (114) (7) Total 5,621 1,366 719 6,945 6,048 7,396 2,753 Source: FSS, Company data

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2017. 5. 29

Surpluses and deficits, by product (as of end-2016) (KRWb) Fixed-with Fixed-without Float-with Float-without Variable Deficit Surplus Sum profit profit profit profit (A) (B) (A+B) Life insurers (37,272.6) (14,561.5) (749.8) 49,881.8 18,637.8 (64,164.5) 80,100.3 15,935.7 Samsung Life (22,730.9) (7,189.3) (577.4) 25,470.2 9,192.1 (30,497.6) 34,662.3 4,164.7 Kyobo Life (5,117.4) (3,374.6) 223.6 11,501.4 (8,492.0) 11,725.0 3,232.9 MetLife (508.7) 393.6 (3.4) 30.8 2,202.5 (512.1) 2,626.9 2,114.8 ING Life (30.6) 1,634.1 (328.8) 484.5 1,413.8 (359.4) 3,532.4 3,173.0 Rhina Life 28.0 (2,950.4) 0.1 (3.7) (22.7) (2,976.8) 28.0 (2,948.8) Dongbu Life (151.3) 38.8 (1.6) 2,232.9 0.0 (152.9) 2,271.7 2,118.8 Shinhna Life 866.9 (627.7) 63.3 (2,015.7) 79.7 (2,643.4) 1,009.9 (1,633.5) Hanwha Life (7,116.3) (2,711.9) (336.3) 7,386.0 4,649.9 (10,164.6) 12,035.9 1,871.3 Mirae Asset Life (776.8) (59.9) (3.6) 995.2 756.4 (840.3) 1,751.6 911.3 NH Life (21.6) 133.5 189.5 1,303.6 0.0 (21.6) 1,626.6 1,605.0 KB Life (23.8) 44.8 0.1 313.0 44.9 (23.8) 402.8 378.9 Prudential Life 4.7 428.5 0.0 (205.9) (521.9) (727.8) 433.2 (294.6) Heungkuk Life 849.5 226.2 (21.8) (1,233.9) (54.4) (1,310.1) 1,075.8 (234.3) Tong Yang Life (1,171.5) 571.6 (9.3) 1,063.1 542.4 (1,180.9) 2,177.1 996.3 IBK Pension 0.0 0.0 7.4 578.8 0.7 0.0 586.9 586.9 PCA Life 4.1 (117.0) 2.6 (6.1) (215.9) (339.0) 6.6 (332.4) KDB Life (601.5) (717.2) 55.6 1,572.8 135.2 (1,318.6) 1,763.6 445.0 Ace Life (0.2) 16.7 0.0 27.7 64.1 (0.2) 108.5 108.3 DGB Life 81.8 219.0 (1.4) (263.1) (59.6) (324.1) 300.8 (23.3) Kyobo Life Planet 0.0 1.2 0.0 5.5 0.0 0.0 6.7 6.7 BNP-Cardif Life 0.0 (3.7) 0.0 37.2 (37.0) (40.7) 37.2 (3.5) Hyundai Life 212.5 109.4 5.1 (522.4) (6.3) (528.7) 327.0 (201.8) Allianz Life (1,069.5) (627.1) (13.1) 1,129.7 473.9 (1,709.8) 1,603.6 (106.1) Non-life insurers (623.5) (465.0) 147.4 22,939.2 0.0 4,000.8 29,774.6 33,775.4 Samsung F&M (59.9) (470.8) 104.9 7,896.8 0.0 (530.7) 8,001.7 7,471.0 Hyundai M&F (401.4) (183.0) 38.5 7,846.2 0.0 (584.3) 7,884.6 7,300.3 Meritz F&M (6.6) 135.4 5.2 3,267.2 0.0 (6.6) 3,407.8 3,401.2 Dongbu Insurance (151.3) 38.8 (1.6) 2,232.9 0.0 (152.9) 2,271.7 2,118.8 MG Insurance - - - - - 1,746.2 2,103.3 3,849.5 Lotte Insurance - - - - - 3,540.8 4,387.0 7,927.9 The K (3.1) 21.8 0.0 21.9 0.0 (3.1) 43.8 40.7 Heungkuk F&M (1.3) (7.3) 0.4 1,674.1 0.0 (8.6) 1,674.5 1,665.9 KB Insurance - - - - - Hanwha non-life - - - - - Source: Company data

Sale of Allianz Life (Korea) Key facts Date of sale Apr 2016 Sale price USD3m Total assets KRW16.7t (end-2015) Shareholder equity KRW994.2b (end-2015) The Allianz Group became subject to solvency II capital regulations in 2016, Notable events which required it to facilitate no more than KRW1t in order to comply Source: Local media, Samsung Securities

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2017. 5. 29

This finalized version of IFRS 17 standards had authorities mulling over whether or not to book CSM as capital instead of liability. The standard originally required a retrospective approach to groups of insurance contracts in accordance with IAS accounting policies, but the end-2016 meeting led to moderation—ie , if a retrospective application is difficult, a modified retrospective approach can be adopted, and if it is also seen a impractical, entities can use a fair-value approach. The latter should be a transitional measure and not applicable to contracts taken once the new standard is introduced, but insurers appear to have avoided the worst-case scenario as it will likely result in smaller CSMs (and thus lower recapitalization needs).

Some say insurers will see minimal effect no matter what IFRS 17 ultimately looks like, as they believe CSM will eventually be booked as capital backed by government support. Still, we believe the fair-value approach would bode well for insurance shares, as: 1) global investors should look at IFRS 17-based capital data—vs ones only acceptable in Korea; 2) the approach—with lower CSM and thus lower liability—ought to mitigate the chance of substantial capital declines and thus ease dividend concerns; and 3) earnings erosion caused by the early recognition of CSM as capital—at present value of its future net income—is irrelevant with corporate fundamentals.

IFRS Staff Paper (IASB Agenda ref 2E): Temporary allowance of fair-value approach Staff recommendations 2. The staff recommend that when an entity applies IFRS 17 for the first time: (a) the entity shall apply the requirements of IFRS 17 retrospectively in accordance with IAS 8Accounting Policies, Changes in Accounting Estimates and Errors to groups of insurance contracts1, unless doing so is impracticable;

(b) for insurance contracts for which the entity cannot identify a group retrospectively, and for groups of insurance contracts for which retrospective application is impracticable , the entity is permitted to choose between a modified retrospective approach or the fair value approach, unless a modified retrospective approach is impracticable, in which case the entity must use the fair value approach;

(c) the objective of a modified retrospective approach is to achieve the closest outcome to retrospective application that is possible using reasonable and supportable information. The entity is permitted to use specified modifications (listed in Appendix B) but shall use the minimum modifications necessary to meet the objective of the modified retrospective approach;

(d) in applying a modified retrospective approach, the entity shall maximize the use of information that would have been used to apply a fully retrospective approach but need only use such information that is available without undue cost or effort; (e) the entity should determine the contractual service margin using the permitted modifications for the variable fee approach at the beginning of the earliest period presented, rather than the date of initial application of IFRS 17; Note: Bold underlining our emphasis Source: IASB

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2017. 5. 29

Gauging insurance liability and earnings under IFRS 17

Retrospective calculation of CSM (original IASB plan) CSM as fair value (KASB proposal)

Regression analysis Fair value (FV) of liability – (BEL + RA) = impossible 4 4 ▶ Time 0 5 0 5-year amortization CSM 20 Future earnings similar -2 -2 -2 -2 -2 ▶IFRS17 adoption to current ones Amortize for next 5 years ▶ IFRS17 adoption CSM 5 -1 -1 -1 -1 -1 CSM 10 BEL+RA 40 -2 -2 -2 -2 -2 BEL+RA 40 Liabilities 45 Amortize for next 5 years Liabilities decrease Liabilities 50 Future earnings > by 5 under FV current earnings approach

Source: KASB

Expected changes to insurers’ balance sheets under IFRS 17

IFRS 4 Phase II IFRS 17 Current (2013 draft) (2016 revision)

CSM Fair value CSM

Surplus BEL + RA contracts Insurance BEL + RA reserves

Deficit BEL+ RA contracts BEL+ RA

Shareholder Shareholder equity equity Shareholder equity

Source: Company data, Samsung Securities

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2017. 5. 29

Stricter RBC regulations (K-ICS) to hit second-tier players While risks associated with the adoption of IFRS17 in 2021 are long-term concerns, the new RBC regulations pose an immediate threat to insurers’ capital. The market has been trying to assess the impact of new supervisory guidelines for insurance (to take effect next month) on RBC ratios since the Financial Supervisory Service (FSS) announced them earlier this year. The possibility that ratios could plunge by more than 1/3 has rekindled capital concerns.

• Calculation of risk in variable insurance reserves: Insurers will have to switch to a scenario-based approach (from a coefficient-based one) when calculating risk in variable insurance reserves, as is the case for the reserves themselves. If a fair- value approach is used for variable insurance reserves, the same must be applied to value the risk.

• RBC calculation for pensions: Under the revised regulations, credit, market, and operation risk (the latter was the only element present previously) must be reflected in calculating RBC ratios for principal-and-interest-protection-type corporate pensions.

• Calculation criteria for interest-rate risk: Stricter criteria will be applied for interest-rate risk—ie , a 30-year segment for liability duration (based on years to maturity) will be added, market yields will be reflected in calculating crediting rates from 2018, and the interest-rate volatility coefficient (used in the interest rate risk calculation) will be cut from 1.85% to 1.5%.

FSS revision to insurance supervisory regulations (announced in January) Area Key points Effective date Tighten risk calculation for Change risk calculation method from a variable- to scenario-based method Jun 2017 35%, Jul 2018 70%, Jul 2019 100% variable insurance products Tighten risk calculation for Add credit and market risk to principal protected pension products Jun 2017 35%, Jul 2018 70%, Jul 2019 100% pension products (from operational only previously) Expand liability duration cap from 20 to 30 years Jun 2017 50%, Jul 2018 70% Tighten interest rate risk Lower liability discount rate to market yield levels Jun 2018 50%, Jul 2019 70% calculation Lower interest rate risk coefficient from 1.85% to 1.5% Jun 2017 Source: FSS

We believe the revised criteria for interest-rate risk calculations will impact insurers, but especially hit the RBC ratios of second-tier players. It is possible that the effects could be less than expected— regulations will not go into effect simultaneously, insurers are adjusting asset durations, and some players are requesting the guidelines be delayed or changed—but with IFRS 17 standards due to take effect in 2021, dramatic improvements are unlikely even if authorities grant a one-year grace period.

Expected impact of new capital regulations on RBC ratios (%pts) Samsung Hanwha Samsung Dongbu Life Life F&M Growing interest-rate risk (113) (66) (107) (45) Expand liability duration from 20 to 30 years (42) (80) (20) Lower liability discount rate to market rate (94) (52) (30) Lower interest-rate risk coefficient from 1.85% to 1.50% 23 25 5 Strengthen retirement-pension products (8) (4) (4) - Apply scenario-based method in variable insurance risk calculation (7) (20) - - Total impact (128) (90) (111) (45) Note: Hanwha Life does not detail expected impacts of interest rate risk Source: Company data, Samsung Securities

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2017. 5. 29

Interest rate hikes: Near-term shocks, but long-term positives

Interest rate hikes

(%) 2.8

2.5

10-year KTB 2.2

1.9 5-year KTB 3-year KTB 1.6

1.3

1.0 May 15 Nov 15 May 16 Nov 16 May 17

Source: WiseFn

Interest rate hikes ought to especially aid insurers, with Samsung Life to benefit in three ways.

Negative investment spread: Samsung Life’s negative investment spread worsened from -19bps at end-FY10 to -69bps at end-FY16, and might well fall to -80bps within a few years absent interest- rate hikes. Assuming KRW152t worth of assets and liabilities matched in duration, we estimate that a 10bps reduction in the negative investment spread would boost the firm’s annual net profit by KRW150b.

Variable insurance provisioning: Samsung Life earned commission income of KRW160b from variable insurance products in 2016 and set aside provisioning of KRW360b for related reserves. The KRW200b impact on profits could become nil this year if yields on five-year KTBs stay at 1.9%, and if rates rise by over 100bps, additional provisioning would be unneeded.

Guaranteed minimum interest: Around 60% of interest-rate-linked product reserves offer 2-4% guaranteed minimum interest. In this prolonged low interest rate environment, crediting rates have slid to around 2.5%, but if they rise, Samsung Life would not have to offer guaranteed minimum interest (which would ease concerns about deterioration of negative investment spreads).

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2017. 5. 29

Samsung Life: New money yield vs investment yield Samsung Life: Additional provisioning for variable insurance vs interest rate

(%) (KRWb) Additional provisioning on variable insurance (%) 6.5 Includes KRW940b one-off bargain 400 products to dissipate if 5-year KTB rate 4.5 purchase gain on Samsung Card remains at 1.9% through year-end. 6.0 350 4.0 5.5 300 5.0 250 3.5 4.5 200 3.0 4.0 150 100 2.5 3.5 50 2.0 3.0 0 1.5 2.5 Investment yield to rebound due to rising interest rates (50) 2.0 (100) 1.0 1Q14 3Q14 1Q15 3Q15 1Q16 3Q16 1Q17 FY10 FY11 FY12 FY13 CY14 CY15 CY16

New money yield Investment yield Additional provisioning for variable insurance (LHS) 5 yr KTB (RHS)

Source: Company data Source: Company data

Minimum guaranteed rate distribution, by firm (4Q16) Samsung Life: Investment margin vs interest rates

(%) (bps) (%) Minimum guarantee rates between 60 2-4% account for 70% of reserves (10) 4.0 50 (20) 3.5 (30) 40 3.0 (40) Negative 30 spread 2.5 (50) expected to 20 2.0 (60) shrink 10 (70) 1.5 0 (80) 1.0 Below 0% 0-2% 2-3% 3-4% Over 4% 4Q11 4Q12 1Q14 1Q15 1Q16 1Q17

Samsung Life Hanwha Life* Samsung F&M Dongbu Investment margin (LHS) 3-year KTB yield (RHS)

Note: Based on floating rate liabilities Source: Company data Source: Company data

There is a problem since positives might only materialize gradually over the next three to five years, but if mark-to-market accounting of liabilities is not implemented, interest rate hikes would reduce asset value and capital while driving down RBC ratios, which would highlight capitalization risk. Recapitalization is not a simple issue, with RBC ratios set to fall from next month in accordance with tighter regulations.

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2017. 5. 29

Interest-rate sensitivity analysis by industry leaders Samsung Life and Samsung F&M show that their RBC ratios would fall to around 350% if market yields rise 50bps, with their net profits projected to rise a respective KRW220b and KRW24b three years thereafter. If interest rates remain steady, however, Samsung Life may not have to provision for variable insurance reserves (estimated to reach KRW400b this year) while possibly writing back some reserves.

Samsung Life: Impact of interest-rate changes Samsung F&M: Impact of interest-rate changes

5-year KTB 50bp increase 1.75% 5-year KTB 50bp increase 1.75% 1.25% 1.25% -KRW2.3t +KRW3t +KRW1.9t -KRW1.2t Bond Bond VIF VIF valuation KRW valuation KRW KRW increase KRW increase loss 28.7t loss EV 15.4t 28t EV 14.7t EV KRW0.7t (+3%) EV KRW0.7t (+4.8%) -KRW2.3t -KRW1.2t KRW KRW KRW 29.4t Bond valuation loss Bond valuation loss KRW

Equity 12t 27.1t Equity 10.8t

388% 403%

RBC 351% RBC 364% Year 1 Year 2 Year 3 Year 1 Year 2 Year 3 Earnings increase KRW196b KRW121b KRW222b Earnings increase KRW5.4b KRW24b KRW24b

Decrease in provisioning (KRW182b)

Source: Company data Source: Company data

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2017. 5. 29

Insurers reluctant to increase capital Insurers are addressing deterioration of RBC ratios caused by regulation tightening, but they appear reluctant to increase capital, and are instead focused on reducing interest-rate risk, by: 1) expanding asset duration through the purchases of long-term and foreign currency-denominated bonds; and 2) reclassifying bond holdings from available-for-sale to held-to-maturity. There seem to be limits on these measures raising RBC ratios, with all domestic insurers buying overseas assets—to address duration mismatches by purchasing longer-dated foreign currency- denominated debt and long-term debt to offset liability duration expansion—but any abrupt changes to investment-asset allocation could backfire, while concentrating assets on bonds might push down investment yields.

RBC ratios (%) 3Q16 4Q16 Change (%pts) Samsung F&M 403.4 336.2 (67.2) Hyundai M&F 222.0 158.3 (63.7) Dongbu Insurance 258.9 173.5 (85.4) KB Insurance 187.9 164.6 (23.3) Meritz F&M 253.3 188.0 (65.3) Samsung Life 388.0 304.0 (84.0) Hanwha Life 289.8 200.4 (89.4) Source: Company data

Insurers respond to RBC declines Company Response Expand asset duration by acquiring long-term foreign bonds Samsung Life Increase retention of earnings (long-term “333 Policy” unchanged) Expand asset duration Samsung F&M Maintain capital policy (dividend payout ratio of at least 30%) Bond reclassification in Jan 2016 (60% HTM, 40% AFS) Hanwha Life Expected to issue perpetual bonds worth KRW500b in 1Q17 Expand asset duration by acquiring long-term foreign bonds Expand asset duration by acquiring long-term foreign bonds Hyundai M&F Issued KRW500b subordinate bonds in May 2017 Expand asset duration by acquiring long-term treasuries/foreign bonds Dongbu Insurance Issued KRW500b subordinate bonds in May 2017 Expand asset duration by acquiring long-term foreign bonds KB Insurance Conducted rights offering worth KRW180b in Dec 2016 Source: Company data, Samsung Securities

Some downplay the implications of rising market yields, saying insurers can bolster RBC ratios by issuing subordinated or perpetual bonds. In fact, market concerns over insurers’ capital facilitation died down after Hyundai M&F and Dongbu Insurance this month each issued subordinate bonds of KRW500b, which is expected to increase their RBC ratios by around 20%. The operating environment has completely altered since 2010: Interest rates were falling at that time and only a few weak players were compelled to issue such bonds, and issuance supplies did not exceed demand, but they probably do so currently.

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2017. 5. 29

KB Insurance recently conducted a rights offering (instead of issuing bonds), with the KRW180b in proceeds expected to boost its RBC ratio by 10%pts, but the firm still likely needs to raise an additional KRW700b-800b. As for Hanwha Life, issuing KRW500b worth of perpetual bonds should boost its RBC ratio by 10%pts, but even that would be insufficient to meet regulatory targets.

Insurers: Capital-raising measures Insurer Period Funding method Size Impact on RBC Hanwha Life 1Q17E Perpetual bonds KRW500b 10%pts (expected) KB Insurance 1Q17E Rights offering KRW170b 10%pts (expected) KRW120b Lotte Insurance Nov 2016 Perpetual/subordinate bonds 25-28%pts (expected) (KRW52b/KRW68b) Heungkuk Life Dec 2016 Perpetual bonds KRW97b Hyundai Life Apr 2016 Subordinate bonds KRW40b 5-10%pts DGB Life Sep 2016 Subordinate bonds KRW20b Source: Local media, Samsung Securities

Our estimates show that the industry needs to raise KRW10t-15t by next year in order to maintain capital adequacy, possibly more if the Bank of Korea were to raise interest rate hikes by 50-70bps in 1H. Under a worst-case scenario, insurers might: 1) issue bonds at higher interest rates—if issuances are expected to spark market yield hikes; or 2) not issue bonds—which could compel them to pursue rights offerings or treasury share sales, with either outcome boding ill for smaller players. Market concerns center on the government’s capital regulations (and subsequent RBC ratio declines) along with IFRS 17, although recent revisions of the latter have eased worries. Under IFRS 17, issuing subordinated bonds might merely become stop-gap measures—as such bonds will not be recognized as capital under ordinary accounting, thus likely causing insurers to seek recapitalization by issuing perpetual bonds or undertaking rights offerings. Financial authorities are encouraging the issuance of perpetual bonds, and at end-April announced a plan to revise insurance industry supervision rules (eg, loosening of criteria for perpetual bond issuances), but demand for these bonds is not expected to be significant, with their issuance not guaranteed. We expect a draft for risk-based global insurance capital standards (ICS) to be issued in July, which should become the BIS equivalent for insurers, then after two years of impact evaluation, a final version should be released in 2019 and be applied globally from 2020. While details remain scant, we expect ICS to be stricter than IFRS 17 (to be introduced in 2021) and call for: 1) the booking of insurance liability at market value; and 2) hikes in required capital for equity holdings [not bonds]. As for Korea, news regarding RBCs—with K-ICS to be introduced next month—also warrants attention in order to keep abreast of the direction of supervisory/regulatory trends.

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Deepening of capital divide

Impact 1) Sales power gap to widen by firm Operational fundamentals ( eg , initial premium growth and loss ratio) are set to diverge, with cash- strapped players likely to be overwhelmed by recapitalization needs (eg, issuance of subordinated/perpetual bonds) and thus avoid activities that might lower RBC ratios. Disparate sales abilities should be most pronounced in auto insurance lines, which were behind improving sector fundamentals, but Samsung F&M is more likely to pursue regaining market dominance since its auto loss ratio and market share gaps with second-tier players have narrowed since early 2016. Notably, the insurer unexpectedly cut its auto insurance premiums at end-2016, but second-tier players did not follow suit, due in part to their higher EPS sensitivity to auto premium cuts, but the primary cause was their profitability focus amid market yield hikes. Auto line negatives ought to outweigh positives for some time, with earnings divergence likely to widen—depending on underwriting and price competiveness—as is the segment’s ratio gap (and thus market share) between Samsung F&M and second-tier players. In additional, several major Korean banks have begun to restrict the sale of bancassurance products from insurers with RBC ratios falling below 150%, including: 1) KB Bank from earlier this month doing so for select bancassurance products sold by Heungkuk Life and KDB Life; 2) KEB Hana Bank doing so for products sold by Heungkuk Life and MG Insurance; and 3) Shinhan Bank being expected to soon do so for all of Heungkuk Life’s such products. These restrictions may have a limited impact the total sales of insurers, but their sales power could nevertheless ultimately take a hit of it undermines the credibility of players with weak capital.

EPS sensitivity analysis: Auto insurance rate cuts* Samsung F&M: Auto insurance market share (KRWb) Samsung Hyundai Dongbu KB Meritz (%) Market share rebounds Auto earned premiums 4,223 2,483 2,835 1,835 690 on auto price cuts and (Base case) 30.5 Expanded market improved price comparability Auto earned premiums share backed 4,117 2,421 2,764 1,789 673 (2.5% cut) 30.0 by price Change (pre-tax) (106) (62) (71) (46) (17) competitiveness 29.5 of online channel Change (after-tax) (80) (47) (54) (35) (13) 29.0 Net profit impact 2017E net profit (base) 1,292 359 520 347 265 28.5 Loses market share after price liberalization 2017E net profit (new) 1,212 312 466 312 252 28.0

EPS impact (KRW) 27.5 2017E EPS (base) 25,558 4,019 7,348 5,782 2,743 27.0 2017E EPS (new) 23,976 3,492 6,589 5,202 2,608 Mar 15 Sep 15 Mar 16 Sep 16 Mar 17 EPS change (%) (6.2) (13.1) (10.3) (10.0) (4.9) Note: * Assumes cut immediately affects current year earnings Source: Company data Source: Samsung Securities estimates

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Impact 2) Disparate investment yields Insurers with asset portfolios that suit capital regulation tightening should be able to enjoy differentiated investment yields, including ING Life, which attracted attention even before its May 12 listing on expectations of its RBC ratio improving (unlike rivals) with next month’s introduction of new RBC regulations (K-ICS). In line with the ING Group’s strict standards, the insurer’s asset portfolio befits Europe’s Solvency II standards, and since those standards place no caps on remaining maturity of liability duration (the strictest mode), ING Life has expanded exposure to long-term bonds while lowering that to loans and alternative investments to match asset-liability duration. K-ICS will likely lift the remaining maturity of liability duration from 20 to 30 years, but the insurer’s duration gap should converge to nearly zero, whereas rivals will likely see their go further into negative territory.

ING Life: Expected RBC ratio changes under K-ICS Duration gaps of life insurers under current RBC regime Old (% pts) New (Years) RBC (%) 319 201 521 4.0 Well prepared for solvency regulation changes Available capital (KRWb) 4,347 - 4,347 Required capital (KRWb) 1,362 201 835 3.0 Interest rate risk 1,118 219 542 Duration gap to decrease drastically after the 2.0 Insurance risk 137 - 137 implementation of extending cap on liability durations Credit risk 229 - 229 1.0 Market risk 51 -18 95 0.0 Operation risk 41 - 41 Note: As of end-2016 (1.0) Source: Company data (2.0) ING Samsung Hanwha Mirae Tong Yang

Note: As of end-Mar 2017 Source: Company data

Investment asset portfolios of life insurers (%) ING Samsung Hanwha Mirae Asset Tong Yang Bonds 87 57 47 48 42 Loans 9 19 22 12 12 Secured loans 9 15 13 7 5 Unsecured loans 0 4 9 5 7 Cash 2 1 1 2 2 Equity investments 1 14 8 16 16 Foreign currency denoted securities 1 5 17 22 22 Other assets - 4 5 1 1 Note: As of end-Sep 2016 Source: Company data

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ING Life’s conservative approach is also shown by its EV actuarial assumptions, and while those for future investment yields vary little in the sector—since yields are dictated more by the macro environment than company-specific management—the firm’s yield assumption is an average 60bps lower than those of rivals, indicative of its stricter internal asset management regulations. Still, K-ICS will likely flip this situation on its head next month, with the rivals of ING Life expected to expand low-margin bond exposure in order to widen their asset durations, but the firm should pursue aggressive reconstitution of its asset portfolio.

Comparison of actuarial assumptions and financial strength indicators ING Samsung Hanwha Mirae Asset Tong Yang Actuarial assumptions Discount rate 8.50% 8.50% 8.50% 8.50% 8.50% Investment yield 2.90% 3.50% 3.45% 3.45% 3.45% Implied risk margin 5.60% 5.00% 5.05% 5.05% Financial strength indicators % of fixed rate exposure * 10.2% 33.3% 31.2% 12.0% 17.3%

% of low risk assets ** 97% 73% 60% 57% 55%

RBC adjusted for LAT *** 305% 84% 39% 129% 160% Duration gap (0.17) 0.62 0.54 0.50 Asset duration 6.38 6.16 6.38 6.76 Liability duration 6.46 7.28 5.85 6.67 Note: * Fixed rate guarantee products > 6% as % of total reserves as of Sep 2016; ** as of Sep 2016; *** as of June 2016 Source: Company data

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Impact 3) Changes to the industry competitive landscape Market yield hikes are not only expected to raise recapitalization issue, but also change the industry’s competitive landscape, since: 1) undercapitalized players will need to focus on raising capital over improving fundamentals [eg , initial premium growth]; and 2) firms without shareholders able to facilitate recapitalization might be forced to restructure. Such developments are bound to reduce the number of sector players and thus reduce competition. Firms with the greatest capital resources, such as Samsung Life and Samsung F&M, and those with large shareholders increasing stakes (ie , those with financial holding companies as parents) stand to benefit the most from looming industry shakeups.

Impact of capital regulations Capital adequacy

Group 2: Financial holdings companies Group 1: Large caps, strong capital

• Expand by acquiring marginal • Prepare for IFRS 17 companies • Acquire competitiveness under IFRS 17 • Upgrade IT infrastructure • Strengthen investment operations

Group 4: Smaller, less-capitalized firms Group 3: Large caps, low capital

• Potential M&A • Need to amass capital • Need to amass capital (rights offerings, subordinate bonds) (subordinate bonds) • Drastic change in management required • Expected to receive close FSS scrutiny • M&A could be an option

Size

Source: Samsung Securities

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Valuation-method changes needed in IFRS 17 era; focus on VNB More moderate rules regarding the early, lump-sum recognition of CSM as capital should ease the recapitalization burdens of insurers, but it will also likely eventually slash their earnings power— although this might be offset some by the lump-sum recognition of negative investment spread (eg, KRW700b-800b pa for Samsung Life) as liabilities. Profits from new contracts are expected to become new earnings power indicators, especially regarding value of new business (VNB). That said, eroded earnings power from the early recognition of CSM as capital is merely a matter of accounting, so the fundamentals of insurers should see little impact. So, what will be the key valuation indicator for insurers during the IFRS 17 era? With book value having become a much more reliable indicator, we recommend using it as a primary valuation determinant, with P/VNB (vs P/E) as a secondary one. Most industry players except a few small life insurers have VNB, which mimics earnings—eg , Samsung Life’s annual net profit exceeds KRW1t with a similar VNB, so its future enterprise value (P/VNB) should be on par with the current figure as calculated by P/E.

Samsung F&M EV analysis (KRWb) FY15 Adjusted net worth (ANW) (A) 9,577 Risk capital (RBC x 150%) 4,375 Value in force (VIF) (B) 5,111 Similar to the concept of CSM Present value of future expected profit 6,532 Capital cost 1,421 Embedded value (EV) (A+B) 14,688 In theory, only VNB affects future net profit 1 year value of new business (VNB) 675 PV of future expected profit 792 Capital cost 118 Source: Company data

We expect P/VNB to more meaningful in valuations than P/E during the IFRS 17 era, and in addition to the absolute size of VNB, investors should also take into account the: 1) VNB portion of value of current business; and 2) quality of new business portfolios—ie , protection- vs savings-type products and high- vs low-risk products.

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EV breakdown, by insurer (KRWb) Samsung Life Hanwha Life Tong Yang Life Mirae Asset Life Samsung F&M Dongbu Insurance Hyundai M&F 2014 EV 24,889 8,363 1,907 1,681 14,225 5,698 4,805 VIF 2,074 (113) 204 143 5,031 2,568 2,535 VNB 1,218 442 60 32 666 397 381 Net profit 1,131 414 158 121 797 400 233 VNB/EV (%) 4.9 5.3 3.1 1.9 4.7 7.0 7.9 P/E (x) 17.4 17.4 7.4 n/a 16.8 9.7 10.0 P/EV (x) 0.9 0.9 0.6 n/a 0.9 0.7 0.5 P/VNB* (x) 19.1 16.3 19.4 n/a 20.1 9.8 6.1 2015 EV 25,298 7,804 1,996 1,957 14,688 6,115 4,833 VIF 1,490 (669) 50 56 5,111 2,635 2,429 VNB 1,180 454 81 48 675 413 390 Net profit 1,084 500 151 122 783 413 203 VNB/EV (%) 4.7 5.8 4.1 2.5 4.6 6.8 8.1 P/E (x) 18.1 12.8 8.3 6.6 18.6 12.1 15.9 P/EV (x) 0.9 0.8 0.6 0.4 1.0 0.8 0.7 P/VNB* (x) 18.6 14.1 15.4 16.8 21.6 12.1 8.3 2016 EV 29,349 8,211 - 2,017 16,087 6,525 5,190 VIF 3,497 43 - 94 5,487 2,743 2,497 VNB 1,212 565 - 60 719 456 456 Net profit 2,130** 382 - 91 841 470 400 VNB/EV (%) 4.1 6.9 - 3.0 4.5 7.0 8.8 P/E (x) 10.2 14.3 - 10.4 14.3 9.2 7.3 P/EV (x) 0.7 0.7 - 0.5 0.7 0.7 0.6 P/VNB* (x) 17.9 9.7 - 15.7 16.7 9.5 6.4 Note: * Based on year-end; ** includes KRW1.2t one-off bargain purchase gain from stakes in Samsung Card and Samsung Securities Source: Company data, Samsung Securities

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Contents

Changes to regulatory environment Since the mid-2000s, financial authorities have been eager to fuel the emergence of a Korean global IB that would befit the nation’s expanding economy. Unlike banks and insurers, the brokerage sector has no dominant player-it is severely fragmented. Also on the authorities’ minds was the potential for major IBs to add value, rather than simply focus on commission income. Government-driven deregulatory measures thus far can be divided into: 1) the Financial Investment Services and Capital Markets Act [FISCMA] announced at end-2005; 2) overhaul of the net capital ratio [NCR] system in Apr 2014; and 3) mega-IB nourishment measures announced by the Financial Services Commission [FSC] in Aug 2016.

FISCMA of 2005 and its revisions in 2011-aimed at creation of mega IBs The main goal of FISCMA is to help the brokerage industry grow and diversify through deregulation, by allowing firms to: 1) engage in more financial activities; 2) add investment products; 3) shift to a system in which they can engage in businesses that are otherwise not prohibited; and 4) offer retail payment and settlement services. These measures suffered setbacks during the global financial crisis, but the basic idea of creating globally competitive IBs survived, as evidenced by FISCMA revisions in 2011, such as allowing brokers with shareholder equity of over KRW3t to engage in new businesses (eg , corporate lending and prime brokerage). Despite a consistent government policy and massive rights offerings in 2011, the industry downturn continued to worsen, so the FSC in May 2013 unveiled the Securities Revitalization Plan, with other measures implemented from Jan 2014 ( eg , extended trading hours), but they have thus far proven largely ineffectual. We attribute IB policy failure to: 1) Korea’s agency-based brokerage industry model; and 2) a lack of new business profitability. Improved economies of scale did little for agency operations, with policies of making brokers bigger (by increasing shareholder equity) fit for the principal investor (PI) model, not an agency one. In FY12, agency operations accounted for 52.1% of the combined net operating profit of the six brokers under our coverage—Daewoo Securities, Mirae Asset Securities, Korea Investment Holdings, Hyundai Securities, Kiwoom Securities, and Meritz Securities—and with brokerage operations not being capital-intensive, increased capital did not enhance competitiveness. In addition, brokers failed to generate reasonable profits for operations begun in 2012, including corporate lending, internalization, and hedge fund/prime brokerage. Hedge funds boasted long-term growth potential, but the market remained small, so related earnings contributions stayed insignificant.

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FISCMA deregulation: 2005-2013 Date Point Details Enacted in 2005 Operations integrated into six categories Financial institutions allowed to Financial investment firms allowed to run securities, asset management, futures, and trust operations carry out multiple functions Regulations on business entry, financial soundness, and operations eased More investment products Fund-specific underlying asset restrictions abolished Investor protection Stricter disclosure requirements Shift to negative system Firms allowed to operate businesses not specifically prohibited, rather than ones specifically permitted Retail payment and settlement Non-banking financial institutions allowed to offer settlement services 2011 (revisions) Financial industry Measure to nurture IB operations • Brokers with at least KRW3t in shareholder equity allowed to enter new businesses

(corporate lending, internalization of securities order execution, and PBS) • Regulations on publicly-held, hedge, and privately-held funds rationalized • Trust operation regulations for banks and insurers eased Market Capital market infrastructure reform • Regulatory approval needed to operate exchanges • CCP for OTC products introduced • Credit evaluation-related regulations transferred to FISCMA Corporations Direct funding tools diversified; effectiveness of general shareholders’ meeting strengthened • Firms allowed to use contingent capital securities and warrants as funding tools • Arbitrary handling of unsubscribed shares restricted • Shadow voting system to be abolished from 2015 Investor protection More effective regulations • Share-price manipulation through OTC derivatives banned • Market-disrupting activities regulated • Monetary penalty system introduced 2013 (revisions) Corporate lending Brokers with at least KRW3t in shareholder equity allowed to operate corporate lending Alternative trading systems Alternative trading systems introduced to promote competition with KRX over price and service Reporting unfair practices Rewards for whistleblowers increased Unviable ITCs ITCs with no AUM for six months liquidated Source: FSC, Samsung Securities

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Overhaul of NCR system in Apr 2014 aimed at promoting different business models FISCMA failed to forestall brokerage profitability deterioration, so the FSC in Apr 2014 introduced a new methodology to calculate net-capital ratios-NCRs, which has been the key measure to gauge the financials of securities brokers for the past 17 years, by: 1) shifting the calculation method to [net working capital - total risk]/ 70% of legally required shareholder equity for each business unit; 2) changing guidelines to improve management recommendation systems; 3) introducing a consolidated-based NCR; and 4) easing regulations for the corporate loan businesses of IB operations. The new NCR was expected to raise the investment room of larger brokers and increase the average NCR of nine players with shareholder equity exceeding KRW1t from 476% to 1,140%, but that of medium and small firms declined from a respective 459% and 614% to 318% and 181% in 2013. Moreover, Korea’s National Assembly in March passed a FISCMA revision bill that requires brokers wishing to engage in OTC derivatives trading to have a minimal NCR of 150% (vs 100% previously), which should increase the room mega IBs have to invest in risky assets by 20-30%. Such developments have smaller players scrambling to survive by either returning licenses or seeking to specialize, which increases the likelihood of industry restructuring focusing on them. Brokers seeking rapid shareholder equity utilization have been more apt to benefit than those with capital power, which has accelerated the transition to PI models.

NCR regulation changes (Apr 2014) Issue Before After (Net working capital – total risk) / 70% of legally required NCR calculation Net working capital / total risk shareholder equity for each license Guidelines to improve Management improvement recommended, required, and ordered Management improvement recommended, required, and ordered management systems at NCRs of 150%, 120%, and 100%, respectively at NCRs of 100%, 50%, and 0%, respectively Introduction of consolidated NCR Securities broker-specific NCR Consolidated NCR Relieve corporate finance Subtract value of loans with maturities longer than 3 months when Instead of subtracting from net working capital, loans are regulations calculating net working capital recognized as credit risk OCT derivative operations* Applies former NCR requirement of 200% and up Applies new NCR requirement of 150% and up Note: * Added in Mar 2017 Source: FSC

NCR ratio comparison of major brokers (end-2016) (KRWb, %) Shareholder equity Old NCR New NCR Mirae Asset Daewoo 6,591 284 2,391 NH Investment & Securities 4,596 237 1,342 KB Securities 4,1 13 328 1,472 Korea Investment Securities 4, 073 339 1,603 Samsung Securities 3,793 399 1,601 Shinhan Investment & Securities 3,079 346 938 Average 4,37 5 322 1,558 Source: Kofia

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Mega-IB nourishment measures announced in Aug 2016 The government failed to generate satisfactory results with its 2011 FISCMA revision and Apr 2014 NCR overhaul, so additional measures to foster mega-IBs were unveiled in Aug 2016, including the classification of brokers by capital size and subsequent consent to license new businesses.

• Mega-broker standards Shareholder equity KRW3t-4t KRW4t-8t KRW8t~ I. 2011 FISCMA Prime brokerage ○ ○ ○

Corporate lending ○ ○ ○ Up to 100% of shareholder equity Identical Identical II. 2016 FISCMA Source of funding for corporate finance operations Commercial paper (CP) — ○ (Up to 200% of shareholder equity) ○ (Same) Investment management account (IMA) — — ○ Deregulations to boost corporate financing operations Relaxed leverage regulations — ○ (Limited to CP) ○ (Limited to CP and IMA) New system for capital adequacy ○ ○ ○ Increase lending cap balance (allows separate cap for corporate lending; up to 100% of equity) ○ ○ ○ Provide universal banking services Trading of unlisted stocks ○ ○ ○ Corporate foreign exchange services — ○ ○ Real estate trust services — — ○ Enhance global competency Increase cooperation with government/sovereign funds ○ ○ ○ Facilitate overseas M&A activities ○ ○ ○ Source: FSC

Such measures target the following three goals. 1) Make corporate funding easier • Capital funding via nationwide banks and venture capital firms has limitations. • Tailored funding should be possible via mega-IBs.

2) Diversify profit sources via expanding business areas • New businesses ( eg , unlisted share trading, forex operations, and real estate-collateralized trust operations) would enable brokers to transform into providers of comprehensive corporate financing services.

3) Strengthen global presence by allowing IB licenses • Mega-IBs are needed for investment in overseas infrastructure projects, and armed with capital power, they can better collaborate with policy-based financial institutions and sovereign funds.

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To flesh out the Aug 2016 measures, the government on May 2 this year announced revisions to FISCMA and Investment Bank Act. Indeed, to reduce systemic risk, officials capped real estate investment by funds raised through CP issuances at 30%. This measure, albeit milder than the Dec 2016 announcement ( ie , capping investments at 10%), reconfirmed the government’s determination to prevent brokers’ asset management from being focused on certain areas by excluding real-estate investment from the mandatory corporate lending investment requirement—ie , over 50% of funds raised via CP issuances must be invested in corporate lending.

Capital Markets and Investment Banking acts (May 2017) Category CP IMA Required capital Minimum of KRW4t Minimum of KRW8t Return policy Promised rate Performance based Issuing limit 200% of shareholder equity Unlimited 50% of raised funds 70% of raised funds Minimum corporate finance portion of investments (excluding real estate investments) (excluding real estate investments) Cap on real estate investments Not to exceed 30% of raised funds Not to exceed 10% of raised funds Regulations on remaining funds Negative-rule based Positive-rule based Account management Separate accounting Trust account Loss provisions None Up to 5% of raised funds - Does not recognize COCO bond proceeds as capital Regulations on capital - Excludes CP and IMA raised funds when calculating leverage ratio. Note: Pending implementation Source: FSC

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Expected impact on earnings With no Korean broker as yet meeting the KRW8t threshold, we analyze potential impacts of new businesses allowed on firms with minimum shareholder equity of KRW4t. The newly-allowed businesses comprise, CP issuances, the trading of unlisted shares, and forex operations, but the latter two will need time to attract clients with one-stop services, so we foresee limited near-term impact. CP issuances have thus far garnered the most attention, with Meritz Securities seen as a benchmark as it generates most of its earnings from corporate financing operations and reportedly enjoys a CP issuance margin of 250-270bps. Several media have reported that Mirae Asset Daewoo Securities will be able to generate KRW300b from the new operation, which assumes shareholder equity of KRW7t (caps CP issuances at KRW14t) and a CP issuance margin of over 200bps. We see such estimates as exaggerated, however, since Meritz is finding success in the niche market, with issuances of KRW2.5t-3t and systems already in place, including an investor pool, risk management system, deal sourcing, and relationships backed by significant experience and knowhow. Conversely, mega-IBs should have difficulty finding new investors, as their combined issuances are likely to surpass KRW40t—ie , KRW14t for Mirae Asset Daewoo Securities, and KRW8t each for Samsung Securities, KIH, NH I&S, and KB Securities. Meanwhile, tough regulations have real estate investments capped at 10% of funds raised via CP issuances, while over 50% of funds raised must go to corporate financing. It is also uncertain whether mega-IBs can raise tens of trillions of won within two or three years, as: 1) they are unable to offer capital protection—nb , deposits of up to KRW50m at Meritz are guaranteed by the government due to its merchant banking license; 2) their margins are bound to suffer if they seek funding by paying special interest rates; and 3) CP demand from institutional investors is unlikely to be significant as they differ little from electronic short-term bonds. Under the worst-case scenario, CP operations will: 1) attract existing CMA clients rather than attracting capital from banks; and 2) amplify systemic risk by encouraging brokers to take on higher risks to meet NIM targets.

Meritz Securities: CP/CMA balance and NIM Meritz Securities: Net operating income

(KRWb) NIM declines with transfer of leasing (%) Other operation to Meritz Capital 5% 3,200 3.2 Wholesale 10% 3,000 3.0 2,800 2.8 2,600 Trading 2.6 15% 2,400 Corporate 2,200 2.4 financing 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 58% 2014 2015 2016 2017 Retail 12% CMA & CP (LHS) NIM (RHS)

Source: Company data Note: As of 1Q17 Source: Company data

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The table below shows pre-tax profit gains for brokers under three average CP issuance balance and margin scenarios.

CP operations: Earnings sensitivity analysis 2017E 2018E

Mirae KIS NH Mirae KIS NH

Daewoo Daewoo Average CP balance (KRWt) 7.0 4.0 4.5 14.0 8.0 9.0 Margin (bps) 100 100 100 200 200 200 Best Change in pre-tax income (KRWb) 70 40 45 280 160 180 ROE (%) 7.0 7.7 7.1 9.7 10.2 9.3 Average CP balance (KRWt) 4.0 2.5 3.0 8.0 5.0 6.0 Margin (bps) 50 50 50 100 100 100 Normal Change in pre-tax income (KRWb) 20 13 15 80 50 60 ROE (%) 6.2 7.0 6.4 7.0 7.6 6.9 Average CP balance (KRWt) 2.0 1.0 1.2 4.0 2.0 2.4 Margin (bps) 0 0 0 50 50 50 Worst Change in pre-tax income (KRWb) 0 0 0 20 10 12 ROE (%) 6.0 6.8 6.1 6.4 6.9 5.9 Source: Samsung Securities estimates

KIS: ROE analysis (KRWb) Net profit Shareholder equity ROE (%) 2017E 253 3,487 7.3 Pre-rights offering 2018E 268 3,685 7.3 2017E 287 4,219 7.0 Post-rights offering 2018E 331 4,479 7.6 Earnings increase breakdown Principal investment size Reinvestment rate (%) Net profit change 2017E 730 4.5 24.9 Current operations (PI*) 2018E 750 4.5 25.6 CP balance Margin (bps) Net profit change New earnings from CP 2017E 2,500 50 9 (Normal case) 2018E 5,000 100 38 Note: Rights offering nets KRW730b; * assumes: 1) reinvestment rate of 4.5%—which is more conservative than Woori Bank’s dividend yield of 5%; 2) dividend payout ratio of 20%; 3) zero funding costs—since KIH bears interest costs fr om its corporate bond issuances Source: Samsung Securities estimates

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New competitive landscape amid altered operating environment

Basic concept of securities industry changing Korea’s securities brokers have mainly focused on agency models, which involve zeri risk-taking and concentrate on platform-linked commission income ( eg , brokerage and fund sales). The model is endangered in this era of distribution channel revolution ( eg , fintech), since anyone with a platform of a certain size can start brokerage operations. The risk-free agency model is already showing cracks, weighed on by: 1) a declining need for a simple broker due to greater access to information amid IT developments; 2) rapid realignment of the indirect investment market following the development of ETFs and rollouts of ETNs, which are easy to trade and charge low fees; and 3) the view that brokerage and fund sales commissions will fall to zero over the medium to long term.

Revenue breakdown of Goldman Sachs Revenue breakdown of Samsung Securities

Net interest Others: 2.5% income: IB fees: 4.7% 6.4% Net commission Other IB: 21.2% Trading and income: 32.58% Principal interest income: transactions 18.3% :15.2%

Investment management: 17.4%

Market making: 30.1% Commissions and fees: 9.6% Financial product sales: 44.1%

Note: As of 1Q17 Note: As of 1Q17 Source: Goldman Sachs Source: Samsung Securities

In sum, a shift in business model seems inevitable for brokers, noting new ones should not need to contrast with existing ones ( eg , PI vs agency; risk-taking vs risk-aversion; or real estate products vs general financial ones). Such classifications over the long term should become meaningless with barriers set to blur. Wealth management (WM) models at brokers are already transforming into a hybrid one in which brokers take risks through PI. Brokers’ WM services heretofore have targeted sales of standalone financial products ( eg , equity-type funds prior to and ELS products after 2010), and under the agency model, brokers were simple distributors that assumed no investment or book value risks, with their core competency determined by brand, branches, and private-banking networks rather than product-sourcing, capital, and research. High net worth (HNW) clients, however, seem to have lost interest in such commodity-like products. Sales pitches that call for buying risky assets when interest rates are low or simply classifying equity- linked securities as mid-risk, mid-return products are outdated in our view. Investors are now only willing to take on risk under certain conditions—eg , products that are promoted by differentiated sources such as private equity funds, can be customized, rely on contrarian thinking, or offer stable yields.

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New WM trends tend to focus on: 1) private-placement; 2) niche areas such as hedge funds, mezzanine funds, and unlisted stocks; 3) overseas assets; and 4) regular dividends. Indeed, large brokers have recently taken a securitization approach to real estate investments, that is, they invest first and seek sales later. Such products—the performance of which is difficult to track in the income statement due to complex accounting—enable brokers to sustain high margins on the back of their exclusivity, uniqueness, and a lack of competition. Moreover, if brokers have strong product-sourcing capabilities, they should be able to expand their customer base even if they lack brand or distribution strength. That said, differentiated product-sourcing is not easy to secure as it requires not only capital power, but also: 1) the ability to innovate and analyze macro trends; 2) well-established networks and strong knowhow developed through deal implementation; and 3) a simple system for decision-making. We thus expect only a few large players to lead the shift.

Cumulative mezzanine funds REIT market Korea: PEF market (KRWb) (KRWt) (KRWt) 1,000 20 14 900 18 12 800 16 10 700 14 8 600 12 6 500 10 400 4 8 300 2 200 6 0 100 4 2009 2011 2013 2015 0 2 New money Investment 2012 2013 2014 2015 2016* '06 '07 '08 '09 '10 '11 '12 '13 '14 '15

Note: * As of Jul 30 Source: Local media Source: Local media Source: Local media

Broker A: Commission rate Pure equity-fund AUM balance ELS issuances and early redemptions

(bps) (KRWb) (KRWt) Average commission 13 rate declining due to 150 12 12 increased portion of 10 direct market access 140 11 (DMA) 130 8 10 6 9 120 8 110 4 7 100 2 6 90 0 5 4 80 Oct 15 Oct 16 Oct 2011 2012 2013 2014 2015 70 15 Apr 16 Apr 17 Apr

Domestic institutions 60 ELS issuances Mar 09 Mar 13 Mar 17 Foreigner investors ELS early redemptions

Source: Industry data Source: Industry data Source: Seibro

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2017. 5. 29

Competition over scale in full swing via M&As and rights offerings FISCMA allowed many large firms to start securities operations in 2008 with the issuance of many new licenses, but industry restructuring is the new norm, with large players eager to enlarge themselves, capital size seen as the key determinant of future business models and profitability. This has been exemplified by M&A activities, especially those involving Woori Investment & Securities (2011), Daewoo Securities (2015), and Hyundai Securities (2016), which helped Mirae Asset Daewoo become Korea’s first mega-IB.

Korean brokers: M&A history Acquirer Target Post-M&A entity Date Deal type NH Securities Sejong Securities NH Securities Jan 2006 Acquisition Eugene Securities Seoul Securities Eugene Securities Mar 2007 Acquisition KB Securities Hanuri Securities KB Securities Nov 2007 Acquisition Doosan Capital B&G Securities B&G Securities Jan 2008 Acquisition Hyundai Motor Shinheung Securities HMC Investment Feb 2008 Acquisition Hyundai Heavy CJ Investment HI Investment Jul 2008 Acquisition Hana Investment Hana IB Hana Investment Nov 2008 Merger Hanwha Hanwha Investment Hanwha Investment Sep 2012 Merger Yuanta Securities Tong Yang Securities Yuanta Securities Jun 2014 Acquisition NH Securities Woori Securities NH Securities Dec 2014 Merger Meritz Securities IM Investment Meritz Securities May 2015 Merger Mirae Asset Securities Daewoo Securities Mirae Asset-Daewoo Dec 2016 Merger KB Financial Group Hyundai Securities KB Securities Mar 2016 Acquisition LIG I&S Leading I&S Potential targets Ebest I&S Golden Bridge I&S SK Securities

…

Source: Local media, Samsung Securities

Mirae Asset Securities/Daewoo Securities Hyundai Securities Details Details

Announced Jan 25, 2016 Announced Feb 1, 2016 Target Daewoo Securities Target Hyundai Securities Acquirer Mirae Asset Securities Acquirer KB Seller Korea Development Bank Seller Hyundai Merchant Marine Trade value KRW2.4t Trade value KRW650b Share (%) 43% Share (%) 22.43% Payment type Cash Payment type Cash Source: Bloomberg Source: Bloomberg

Financials

2017. 5. 29

Brokers: Capital-raising measures Samsung Securities KIS Meritz Shinhan I&S Period Mar 2017 Dec 2016 Apr 2017 Aug 2016 Fully acquired Meritz Capital via Method Rights offering Rights offering Rights offering share swap KRW1.69t Size KRW354.4b KRW382.6b KRW500b (net proceeds of KRW730b) Projected post-offering capital KRW4.15t KRW4.03t KRW2.2t KRW3.04t (3Q16) Previous (2011) Samsung Daewoo Woori KIS Period Nov 2011 Oct 2011 Nov 2011 Oct 2011 Rights offering Method Rights offering Rights offering Rights offering (KIH corporate bonds) Size KRW408b KRW1.24t KRW636b KRW730b Post-offering capital* KRW3.22t KRW3.87t KRW3.4t KRW3.08t Note: * As of end-2011 Source: Local media, Samsung Securities

Differentiation via killer apps, focus on investment business All Korean brokers are in dire straits, but most smaller players are on the brink of collapse due to regulations aiming to force out nonviable players (eg , tightening call loan limits). Many wonder what recourse these companies have, so we offer three possible solutions. First, they must break free from their myopic obsession with quantitative indicators ( eg , equity trading-based market share) and seek differentiated long-term strategies, with Meritz Securities and Shinyoung Securities being representative success stories. Second, brokers with ample retained earnings, but the inability to distinguish themselves from rivals, need to focus on investment operations—ie , seeking a deposit rate plus alpha by utilizing shareholder equity-instead of expanding whole/retail ones, with the former likely to benefit large shareholders. Third, marginal firm should focus on boosting shareholder value (eg , through exit plans or capital reduction), rather than being overly reliant on M&A activities.

Action plans needed by smaller brokers

Differentiation via killer apps

1 • Consist organizational unity and vision thanks to simple governance structure • Flexible and quick decision making • Regulatory entry barriers ( eg, merchant banking license)

Focus on investment business

2 • Abandon retail operations after recognizing lack of ability to differentiate • Concentrate on investment business ( eg , seeking deposit rate plus alpha) • Business structure suitable to investment business

Source: Company data

Financials

2017. 5. 29

Action plan 1) Differentiation with killer apps In an industry requiring economies of scale, small players find it difficult to establish competitiveness, but they nevertheless boast qualitative strengths in: 1) organizational consistency, thanks to simple corporate governance structures; 2) flexibility; and 3) quick decision making. Organizational consistency is difficult for large brokers to sustain, as their stakeholder composition is complicated and CEOs seldom last. Conversely, small brokers (most of which are family-owned) make quick decisions and boast highly predictable organizational vision. Since having a few talented personnel is critical for brokers, especially in IB, such employees should produce good results when given discretionary power or room to maneuver. Among small domestic players, Meritz Securities stands out, and even as most large players suffered earnings deterioration in 2016 amid an industry downturn, the company boasted solid profitability thanks to being the nation’s only licensed merchant bank, which allows it to: 1) secure funds at lower costs through government-guaranteed CMAs; 2) subtract only 8% of loans extended from net working capital-other brokers must reflect 100%; and 3) enter high-margin businesses such as discounted bills and leasing. Meritz’s core strength is in corporate financing, which comprises project financing, IB, and merchant banking, with its real-estate PF business continuing to enjoy high profitability—despite tighter risk control amid recent real-estate market slowing—thanks to high-margin deals. Notably, the company has made only one loan over the past nine years linked to poor pre-sales, which is another sign of its differentiated risk control ability in real-estate PF. This shows that even if large brokers enter the real-estate PF market after starting CP issuance operations, they should enjoy competitiveness in the former. Meritz Securities’ NIM recently contracted due to strengthened risk management for domestic real- estate PF deals and downsizing of lease operation, but it strives to diversify its corporate financing portfolio with a securitization business that: 1) purchases and disposes of property—eg, the KRW264b Deutsche Telkom HQ; and 2) signed a KRW1t aircraft financing deal with GE CAS. The firm also seeks new growth engines, as evidenced by its plan to develop real estate-linked WM products and buy real estate in EMs ( eg , Brazil, Lybia, and Turkey) from 2H. Meritz Securities is also prepping for the 2020 expiration of its merchant banking license, while its guidance has shareholder equity of KRW3t by that year, backed by new businesses and likely achievable, since its: 1) shareholder equity is an estimated KRW2t following its Apr 2017 merger with Meritz Capital; and 2) annual net profit should exceed KRW250b [includes Meritz Capital].

Financials

2017. 5. 29

Meritz Securities: CP/CMA balance & net interest margin Meritz Securities: Corporate finance portfolio

(KRWb) NIM declines with transfer of leasing (%) (KRWb) 3,200 operation to Meritz Capital 3.2 3,500 3,000 3,000 3.0 2,500 2,800 2,000 2.8 2,600 1,500 2.6 1,000 2,400 500 2,200 2.4 0 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 1Q15 3Q15 1Q16 3Q16 1Q17 2014 2015 2016 2017 Loans Call loans / sundry deposits CMA & CP (LHS) NIM (RHS) Lease contracts

Source: Company data Source: Company data

Meritz Securities: Corporate finance net operating income Meritz Securities: Net profit and ROE

(KRWb (KRWb) (%) Focused on high-margin deals 1,400 despite tightening risk management 350 Fast growth after 30 acquiring merchant 300 banking license in 25 1,200 250 FY2010 20 200 1,000 15 150 10 800 100 50 5 600 0 0 FY09 FY11 2013 FY15

400 Net profit (LHS) ROE (RHS) 1Q14 3Q14 1Q15 3Q15 1Q16 3Q16 1Q17

Source: Company data Source: Company data

Financials

2017. 5. 29

Action plan 2) Focus on investment business Bookook Securities, Yuhwa Securities, and Hanyang Securities are not household names, so few investors are aware that their ROEs exceed 5%, with all three players: 1) boasting long histories having been founded in the 1960s and 1970s; 2) retaining ample liquidity thanks to diverse investments in real estate and equity; and 3) being family-owned with a few large shareholders.

ROEs of Bookook, Yuhwa, and Hanyang Shareholders’ equity of Bookook, Yuhwa, and Hanyang (KRWb) Paid-in- Capital Capital Retained AOCI Total (%) capital surplus adjustment earnings 13 Bookook 67 134 (33) 180 110 459 11 Roughly matains 5% level Hanyang 66 5 (1) 125 69 265 9 Yuhwa 74 127 (31) 188 90 449 7 Note: As of end-Mar 2017 5 Source: FSS 3 1 (1) (3) FY00 FY04 FY08 FY12 2016

Bookook Yuhwa Hanyang

Source: FSS

Majority shareholders of Bookook, Yuhwa, and Hanyang (%) Majority Treasury stake Total Majority shareholders shareholder stake Bookook 27.4 33.4 60.8 Junggeon Kim, et al . Hanyang 40.8 0.0 40.8 Hanyang School, Kyungsun Baek, Jongryang Kim, and Jongsik Kim Yuhwa 51.4 21.3 72.7 Kyungrip Yoon, et al . (Jiwon Ahn, Jangsup Yoon, and Jungyoon Park) Note: As of end-Mar 2017 Source: FSS

We view the three brokers’ operations as more investment like than being securities brokers, with all three seeking deposit rates plus alpha from shareholder equity (vs concentrating on brokerage or fund sales). As of 2016, the combined net interest and prop trading income of Bookook, Hanyang, and Yuhwa accounted for a respective 56.8%, 58.0%, and 69.4% of their net operating income, with none of three appearing interested in expanding operations via new branch openings or by adding staff.

Financials

2017. 5. 29

Net operating income of Bookook, Hanyang, and Yuhwa (KRWb, %) FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 2014 2015 2016 Net operating income 63.3 58.5 77.5 81.1 95.8 97.5 94.0 82.1 75.2 75.7 106.5 107.0 Net commission income 25.4 24.1 40.1 22.4 33.4 32.2 54.5 53.9 46.8 40.3 45.3 39.6 Brokerage 21.5 17.0 29.9 20.8 21.0 21.4 25.8 15.9 14.1 8.2 12.4 10.2 Fund sales 1.0 0.6 1.0 1.2 1.7 1.8 1.6 0.0 1.2 0.8 1.0 1.0 Net interest income 16.8 22.5 18.3 32.8 34.5 58.3 34.7 14.8 22.1 23.2 48.8 42.1 Net trading income 12.9 5.8 10.0 27.7 21.9 (4.0) 2.2 11.8 5.0 11.6 10.1 18.7 Bookook SG&A costs 40.6 42.4 53.5 60.1 69.2 64.5 72.0 71.6 68.7 55.0 76.3 71.8 Net profit 16.5 12.5 21.1 18.0 22.6 26.9 17.5 5.9 4.5 15.4 24.8 27.8 Shareholders’ equity 224.7 228.2 299.3 330.9 350.4 381.0 397.1 383.1 376.5 397.3 424.0 458.3 Total dividends 10.0 8.5 10.4 10.4 10.4 10.4 10.4 5.1 0.0 0.0 0.0 0.0 Payout ratio (%) 60.7 68.4 49.2 57.5 45.9 38.6 59.4 85.7 0.0 0.1 0.1 0.0 Dividend yield (%) 6.6 5.6 3.2 6.7 3.7 5.6 5.9 2.9 2.9 6.6 7.5 6.4 Number of employees 264 259 252 240 241 254 276 245 209 203 208 202 Net operating income 68.8 67.5 81.5 68.2 81.5 73.2 71.2 50.0 48.9 41.1 56.0 51.4 Net commission income 40.5 41.6 54.8 40.7 44.3 39.7 32.5 17.3 18.7 16.7 23.6 18.7 Brokerage 33.5 24.4 37.3 23.6 26.7 24.9 25.6 13.7 13.6 9.6 17.2 11.1 Fund sales 2.2 1.8 2.1 1.9 2.0 2.3 1.9 1.9 2.0 1.8 1.9 1.1 Net interest income 7.8 10.1 13.0 12.8 11.0 16.3 8.5 8.1 8.0 5.4 7.8 8.5 Net trading income 19.6 15.0 13.9 13.0 23.2 13.9 28.1 18.3 17.2 16.8 21.9 21.3 Hanyang SG&A costs 48.2 48.7 53.1 49.9 52.7 54.3 53.6 43.3 42.6 32.8 44.3 42.6 Net profit 15.6 12.0 20.3 13.2 21.5 13.5 7.5 5.0 4.6 6.3 7.7 6.9 Shareholders’ equity 159.2 161.8 222.0 222.8 243.4 260.5 268.7 263.0 256.1 259.8 262.6 268.3 Total dividends 7.9 7.9 9.9 7.9 9.9 9.9 5.3 3.3 0.0 0.0 0.0 0.0 Payout ratio (%) 50.8 66.0 49.0 60.3 46.2 73.5 70.5 66.6 0.0 0.4 0.2 0.3 Dividend yield (%) 5.2 5.0 4.1 7.8 7.0 7.8 6.3 3.8 4.0 5.0 5.5 4.8 Number of employees 382 356 358 341 307 351 295 287 276 255 246 222 Net operating income 31.2 26.9 34.6 38.2 32.6 22.4 18.2 19.3 17.1 14.7 21.0 16.3 Net commission income 10.2 6.9 9.8 4.9 4.0 3.0 2.8 2.8 2.8 3.2 4.0 2.8 Brokerage 9.2 7.0 9.8 4.8 4.0 2.9 2.8 2.4 2.4 2.9 3.7 2.6 Fund sales 0.8 0.3 0.4 0.2 0.1 0.3 0.3 0.7 0.7 0.5 0.6 0.4 Net interest income 11.8 13.1 16.7 23.3 21.7 14.7 14.0 13.3 13.1 9.4 10.5 10.6 Net trading income 7.7 5.7 6.3 7.7 4.4 1.1 (1.2) 1.5 (0.4) 1.8 4.7 0.8 Yuhwa SG&A costs 15.2 14.2 16.4 16.7 13.4 11.6 11.2 11.2 10.9 8.3 10.4 10.1 Net profit 16.1 12.5 17.1 21.7 20.6 15.6 12.4 12.8 12.5 8.2 10.5 7.7 Shareholders’ equity 332.5 343.2 344.1 404.0 411.2 429.4 471.4 471.4 468.9 461.0 466.3 469.4 Total dividends 9.7 7.6 10.0 10.6 11.2 10.0 7.8 8.4 0.0 0.0 0.0 0.0 Payout ratio (%) 60.3 60.7 58.4 48.8 54.5 63.9 62.6 65.4 0.0 0.2 0.2 0.2 Dividend yield (%) 4.2 3.6 3.0 6.2 5.6 4.5 3.8 4.8 5.1 3.0 4.7 5.5 Number of employees 168 141 173 137 110 99 88 84 74 74 63 68 Source: FSS, Samsung Securities

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2017. 5. 29

Investors may wonder why large shareholders of small securities brokers do not push for change, but the positives of this status quo include: 1) greater tax efficiency when private funds are invested; 2) the prestige of being CEO of a listed firm; and 3) book value increases when investments are made with safe assets. Even during liquidation, large shareholders can usually secure cash equal to book value, so stakeholders raise the shares at P/Bs of less than 0.5x. This investment business model appears beneficial to family-owned brokers.

Small brokers: Reasons for majority shareholders to continue business

Majority shareholders prefer business continuation

Causes

1) Tax benefits

2) Symbolic value of being the CEO of a listed company

3) Stabilized book value after investing in safe assets

In case of liquidation, cash equivalent to book value can be secured

Continue purchasing stock at 0.5x P/B

Source: Samsung Securities

Small brokers: Share purchases of majority shareholders Company Period Number of shares May 3 2016 2,150 Nov 10 2016 14,308 Nov 11 2016 3,830 Bookook Nov 25 2016 1,033 Nov 25 2016 1,033 Dec 8 2016 16,000 Dec 12 2016 19,200 Nov 4 2016 1,349 Nov 7 2016 2,700 Nov 8 2016 2,593 Shinyoung Nov 9 2016 996 Nov 10 2016 2,375 Nov 11 2016 4,400 Jan 21 2016 1,202 Jan 22 2016 2,000 Jan 25 2016 3,000 Yuhwa Jan 26 2016 2,000 Jan 27 2016 3,785 Jan 28 2016 1,000 Feb 5 2016 1,399 Note: Includes preferred shares Source: FSS, Samsung Securities

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2017. 5. 29

Utilization of capital more important than its size There is no correct answer, and even though brokers are in an era in which capital size shapes corporate strategy, the end goal—ie , increasing shareholder value—is unchanged. One quantifiable measure of this is ROE, naturally, so all strategic decisions and capabilities should go toward maximizing it, while blaming low ROE on significant capital cannot be seen as a valid excuse. This is why the utilization of capital is just as important as its size. Although brokers can employee various methods to raise ROE, we believe the main types: 1) maximize principal investments [PI] and wealth management [WM] with operations that use an exclusive investment network, 2) actively manage risk exposure, and 3) diversify business via subsidiaries.

PI and WM products in differentiated network We see Mirae Asset Daewoo as the most capable domestic player of utilizing a WM + PI hybrid business model, and while some still worry about post-merger side effects from two different corporate cultures, we see the new entity as promising, since it: 1) should be able to engage in various types of deals following by its planned sale of treasury shares, which is expected to lift its capital to KRW8t; 2) can offer customers more choices in terms of exposure to other countries given its extensive overseas networks and experience; and 3) should enjoy leverage if the market booms thanks to an extensive distribution network of 174 branches and it sizeable customer base. In April, Mirae Asset Daewoo issued KRW300b worth of senior bonds and KRW100b of commercial bonds to finance a KRW400b investment in the Landmark 72 building in Hanoi at the time it was purchased by global restructuring player AON BGN. The product has a six-month maturity with an annual guaranteed return of 4.5% and minimum subscription of KRW200m.

Landmark 72 ABS structure

Issued ABS with Liquidity provider 6 month maturity Mirae Asset VLM No. 1 LM No. xx Investors Securities

Vietnam Landmark Issued ABS with 72 related loans 5 year maturity Coupon guaranteed by Mirae Asset

Source: Local media

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2017. 5. 29

Landmark 72 ABS overview • Short-term fixed income investment appetizing yield: 4.5% APR, matured on Jan 30, 2017 Key features • Guaranteed coupon: 4.5% interest payment guaranteed by Mirae • Secured by Mirae’s PI (KRW100b in junior CBs) Construction cost Appraisal value

Local Vietnamese loans: KRW7.5b (USD6.5m) KRW900b KRW768.5b-821.6b Mirae senior loans: KRW300b (underlying for ABS) Mirae convertible bonds: KRW100b AON BGN convertible bonds KRW100b Total borrowings: KRW507.5b Investment Loan to value (overall) 56.4% 66.0-61.8% structure By loan seniority 4th placement: AON BGN CBs 56.4% 66.0-61.8% 3rd placement: Mirae CBs 45.3% 53.0-49.6% 2nd placement: Mirae senior loans 34.2% 40.0-37.4% 1st placement: Local Vietnamese loan 0.8% 0.98-0.91% Source: Company data The product is considered mid-risk, since: 1) it is not principal-protected; 2) forex risks exist given volatility of the Vietnamese dong; and 3) refinancing could be an issue if long-term renters are scarce or the product matures. Again, however, there appears to be ample demand for such products in the low interest rate era. Mirae has said it intends to expand its offerings of differentiated products (such as those offering returns of over 4%), so we believe it warrants attention. Nonetheless, there appears to be ample demand for mid-risk products in today’s low-interest rate environment. Mirae Asset Daewoo has also announced plans to strengthen its line-up of unique mid- risk products that utilize its capital power, so we expect its principal investment portfolio to become more diversified than its real-estate oriented one. The Mirae Asset Group last year said it would set up a new growth fund that will invest KRW1t in venture firms annually starting this year, with Mirae Asset Daewoo in Sep 2016 establishing a new growth investment center dedicated to the fund that invested KRW45b in Mirae Asset Naver New Growth Investment Corp #1.

Mirae Asset Group: Major principal investments Invested asset Location Total invested Amount invested by Year amount Mirae Asset Daewoo Shanghai Mirae Asset Tower Pudong and Shanghai KRW260b KRW38b 2006 Acushnet (listed in 2016) US KRW1.3t KRW106b 2011 1081 K Street (housing FRB) Washington DC KRW460b KRW30b 2014 Four Seasons Hotel Seoul, Korea KRW520b - 2015 Fairmont Hotel San Francisco KRW520b KRW149b 2015 FedEx logistics center Six US cities KRW510b 2016 KRW100b Office building Köln KRW490b 2016 Hyatt Regency Waikiki Beach Resort & Spa Hawaii KRW900b KRW348b 2016 Amazon HQ Seattle KRW290b KRW17b 2016 State Farm office building Dallas KRW950b KRW195b 2016 Yeosu Beach resort Yeosu KRW1.1t Unknown 2016- Source: Company data

Mirae Asset venture fund Category Key information Investment size KRW1t pa (currently KRW350b) Funding method Mirae Asset and general partner at matching ratio of 1:1 Investment areas Domestic/overseas venture firms engaged in biotechnology, healthcare, AI, IoT, robot technology, smart agriculture, and EVs General partners Naver (KRW50b), Celltrion (KRW75b), GS Retail (KRW50b), LG Group (TBD), SK Group (TBD) Source: Local media

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2017. 5. 29

Expand risk exposure in principal investments The easiest method for brokers to increase risk exposure is with trading operations by having the highest capital utilization, so they do not require additional business licenses and in theory should allow maximum leverage. Brokers have been active bond traders in recent years, so these activities are having a greater influence on earnings, but with market yields facing upward pressure since 2H16—on increased interest-rate volatility and expectations of the US Fed hiking its key rate—sector players have become more conservative on such activities. At end-Dec 2016, Korean brokers saw post-hedging bond durations average 0.57 years, down 0.21 years from the end-Sep 2016 level of 0.78. During that three-month period, their interest-rate risk (post-hedging duration x bond holdings) fell from KRW144t to KRW100t, with duration cuts accounting for KRW35t of the decline.

Brokers: Bond trading income vs yields on 3-year KTBs

(KRWt) (%)

2.0 3.0

1.5 Fed Trump elected 2.5 announces president 1.0 exit strategy 2.0

0.5 1.5

0.0 1.0

(0.5) 0.5 3QFY12 1QFY13 3QFY13 2Q14 4Q14 2Q15 4Q15 2Q16 4Q16

Bond trading income (LHS) 3-year KTB yield (RHS)

Source: FISIS, NICE Credit Ratings

Brokers: Bond duration, by size* Brokers: Total bond balance, by size* Brokers: Interest rate risk, by size*

(Years) Conservative trading leads to (KRWt) (KRWt) shorter durations Bond balance relatively 0.9 200 183 160 144 Total interest rate 175 unchanged 0.78 0.79 180 risk exposure 0.8 0.77 0.79 0.74 160 dropped by 24% 120 0.7 140 100 0.6 111 110 87 0.6 0.57 120 100 80 66 0.5 80 32 0.4 60 40 40 24 25 33 33 0.31 40 32 10 0.3 20 0 0.2 0 Total Small Medium Large Total Small Medium Large Total Small Medium Large

Sep 2016 Dec 2016 Sep 2016 Dec 2016 Sep 2016 Dec 2016

Note: * Small = less than KRW1t in capital; Note: * Small = less than KRW1t in capital; Note: * Small = less than KRW1t in capital; Medium = KRW1t-3t; Large = over KRW3t Medium = KRW1t-3t; Large = over KRW3t Medium = KRW1t-3t; Large = over KRW3t Source: FISIS, NICE Credit Ratings Source: FISIS, NICE Credit Ratings Source: FISIS, NICE Credit Ratings

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2017. 5. 29

Although we believe that brokers’ overall risk appetite in its trading operations should tone down, we also expect brokers to expand PI investment and manage bond duration gap flexibly. Indeed, Meritz Securities is maximizing S&T gains via flexible trading strategy and adequate risk management. Despite market yield hikes since end-2016, its trading gains rose in 4Q16 and 1Q17, which we attribute mainly to efficient bond trading, given its insignificant issuance of ELS products (vs other brokers). Large brokers are also expanding risk-taking in trading, mainly in PI-linked operations (unlike in Meritz Securities). Samsung Securities, which had tended to be conservative in regards to risk taking, has doubled PI exposure ytd and plans to soon hire more traders for bonds and derivatives.

Meritz Securities: 3 year KTB vs net trading income Samsung Securities: Expanding PI and trading personnel

(KRWt) (%) Plans to increase number of Meritz recorded increasd 110 fixed income & derivatives traders 400 trading gains despite an 3.0 (Up to 30 more) rising interest rate 2.8 80 environment 2.6 300 2.4 2.2 2016 2017E 2018E 200 2.0 1.8 1.6 100 1.4 Increased PI investments by 100% 1.2 Hedge purpose investment → create synergies 0 1.0 1Q14 3Q14 1Q15 3Q15 1Q16 3Q16 1Q17

Net trading income (RHS) 3-year KTB (LHS) 2016 2017 Source: Company data Source: Company data

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2017. 5. 29

Business diversification, maximizing synergy creation with affiliates Despite a years-long industry downturn, KIH sustained high profitability, backed by its diverse business structure, which is one reason for its valuation premium. Ironically, the company’s stable earnings power being seen as a key investment point led to reduced interest in its securities affiliate Korea Investment & Securities (KIS). Moreover, the latter’s failed merger attempts with Daewoo Securities and Hyundai Securities raised concerns over its competitiveness in an era of mega-IBs, which hit the parent’s valuation premium.

KIH: Net profit and ROE KIH vs Securities brokers*: P/B

(KRWb) (%) (x) 350 14 1.5 Historical ROE well over industry average KIH traded at premium over sector 1.4 300 12 due to its stable earning power Premium 1.3 shrank after 250 10 1.2 continued 200 8 1.1 M&A failures 150 6 1.0 0.9 100 4 0.8 50 2 0.7 0 0 0.6 2009 2010 2011 2012 2013 2014 2015 2016 0.5 May 11 May 13 May 15 May 17 Net Profit (LHS) ROE (RHS) KIH Brokerage sector index

Source: Company data Note: * KOSPI Securities brokers index Source: FSS, Samsung Securities

KIH net profit: 2010 vs 2016

Other: -6.4% Other: -7.7% KIMSB: 5.3% KIP: 7.1% KIVAM:1.2%

KIS: 8.6% KITCM: 14.9% KIS: 85.1%

KIMSB: 2010 11.9% 2016

KIVAM: 4.3%

KIS: KITCM: 8.7% 67.2%

Source: Company data, Samsung Securities

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2017. 5. 29

We nevertheless note that KIH’s earnings stability owes to synergies created among affiliates and KIS, with most of latter’s earnings ( nb , its 1Q net profit topped KRW140b) come from non-agency operations, indicating that its business model is being transformed. Profitability at non-securities affiliates remains solid, the collaboration with which allows KIS to offer differentiated products. The core competence of KIH lies in its ability to: 1) capture business using a streamlined structure and rapid decision-making; and 2) allocate assets to suitable areas in a timely manner.

KIH

(KRWb) Assets Equity Net profit 100% KIS 35,539.2 4,131.5 130.1 100% KITMC 242.0 103.2 5.9 100% KIVAM 43.5 27.4 3.2

KIH KIP 357.2 213.0 (4.5) 100% • Assets: KRW37.3t EQ Partners 39.3 18.0 8.9 • Shareholder equity: KRW3.5t 100% • Net profit: KRW271.6b KIARA --- 58% Kakao Bank 274.2 272.3 (8.1) 100% KIMSB 2,248.8 205.6 20.8 100% KIC 1,578.2 192.5 8.0

Note: As of 1Q17 Source: Company data

KIS is already shifting from an agency model to one offering differentiated WM products and PI investment. The firm’s net operating income breakdown shows that unlike in the past—when its key profit source was online/offline retail brokerage commission and asset management fees (led by ITC subsidiaries Korea Investment Trust Management Company (KITMC) and Korea Investment Value Asset Management (KIVAM)—its key earnings driver since 2014 has been IB commissions (from domestic real-estate PF deals) and PI operations ( ie , direct investment and hedge funds). The underlying reason for this successful transformation lies in collaboration with affiliates.

KIS: Net operating income

(KRWb) Sales contribution of agency business 300 (brokerage & wealth management) declining, while trading and IB (real-estate) income 250 increasing

200

150

100

0 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17

Brokerage commissions Interest income Wealth management IB Trading income

Source: Company data

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2017. 5. 29

KIS: IB fee income KIS: Overseas real estate and alternative investments Period Invested asset Amount Deal progress (KRWb) Real estate project financing related income to 500 decrease in the future due to bearish outlook on the Jan 2016 Amazon logistics center, Poland KRW100b Completed Department of Health bldg. 450 domestic real estate market Jan 2016 KRW200b Completed 400 Canberra, Australia 350 Feb 2016 IRS bldg. Philadelphia, US KRW400b Completed Department of Labor bldg. 300 Mar 2016 KRW200b Completed 250 Brussels, Belgium Solar power plant, Yamaguchi, 200 Oct 2016 KRW200b Completed Japan 150 Oct 2016 G-Square, Pyeongchon, Korea KRW900b Completed 100 50 Dec 2016 Singapore Air aircraft KRW100b Completed 0 Dec 2016 Novartis office bldg., Paris, France KRW480b Completed 1Q14 3Q14 1Q15 3Q15 1Q16 3Q16 1Q17 Jan 2017 Etihad Airways aircraft KRW100b In progress Real estate M&A ECM DCM Mar 2017 NASA office, Washington DC KRW140b In progress Source: Company data Source: Company data

The growth of non-securities affiliates shows the increased competitiveness of KIS. WM profit soars over 2010-2014 on ITC utilization KIS has moved from a brokerage commission-centered operation toward WM expansion, backed by its ITC subsidiaries KITMC and KIVAM, which allows it offer differentiated financial products, including growth funds and value/dividend ones. Both subsidiaries developed diverse theme funds over 2010-2014, which helped KIS enjoy significant gains in the equity-type fund market over that period. Recently, the two ITCs have seen equity fund asset contract, but their AUMs keep growing, thanks to solid bond and other fund performances. Annual WM fees of around KRW100b have helped KIS ease the volatility of its brokerage operation.

KITCM + KIVAM: Assets under management KIS equity-type fund market share

(KRWt) (%) 50 24

40 Achieved strong growth 22 between FY10~FY14 on Expanded wealth management operations the back of equity funds 30 20 through AUM growth of ITC subsidiaries 20 18

10 16 14 0 FY10 FY11 FY12 FY13 FY14 FY15 FY16 12

Other 10 Fixed income and fixed income hybrid FY10 FY11 FY12 FY13 FY14 FY15 FY16 Equity and equity hybrid

Source: Company data Source: Company data

Financials

2017. 5. 29

2015-present: Strengthening of real-estate IB, offering of WM products KIH strengthened its IB competitiveness by utilizing its savings bank and capital subsidiaries, and unlike peers, subsidiary Korea Investment Mutual Savings Bank has sought corporate lending operations over retail ones and rapidly expanded assets ( eg , real-estate-secured loans) since merging with Yesung Bank in 2014. Subsidiary Korea Investment Capital is another positive, as: 1) it has fewer conflicts of interest with the IB operation of KIS —since it focuses on near-term gains and risk management; 2) it boasts strength in lending screening; and 3) a leverage ratio of 10x makes for a more efficient corporate lending operation. KIS focuses on offering differentiated WM products by utilizing synergies with other affiliates, notably with trust-type venture funds and real-estate PF loan funds, with the: 1) former a fund of funds that involves select venture firms that have been put in a trust; and 2) latter based on funds owned by Korea Investment Mutual Savings Bank and Korea Investment Capital. This year, KIS aim to sell over KRW550b worth of WM products produced with affiliates, with it also seeking synergy by launching WM products linked to its IB operation, with a full-year sales target of KRW300b.

KIC: Loan balance KIMSB: Total assets and net profit KIP: Invested assets

(KRWt) (KRWt) (KRWb) (KRWt) 1.6 2.4 90 1.8 1.4 2.2 80 1.6 1.2 70 2.0 1.4 1.0 60 1.8 0.8 50 1.2 40 0.6 1.6 1.0 30 0.4 1.4 20 0.8 0.2 1.2 10 0.6 0.0 1.0 0 0.4 2015 2016 1Q17 2013 2015 2017* FY13 FY15 1QFY17 Secured corporate loans Total assets (LHS) Real estate PF loans Venture fund Private equity Technology loans Net profit (RHS)

Source: Company data Note: * 1Q17 annualized figures Source: Company data Source: Company data

KIS: Cross-affiliate WM products KIS: Cross-business WM products Affiliate WM product Product Key features • PF loan fund • KIS exclusive IPO fund Exclusive IPO fund - Targeted sales amount: KRW200b - Completed: KRW56b (Jan 31, 2017) KIC - Investment thesis: Senior loans held by KIC Overseas real • Overseas commercial real estate fund - Target return: IRR 4.5% estate fund - Completed: KRW90b (Mar 30, 2017) • PF loan fund • Mezzanine securities of listed firms (CB, BW, RCPS) - Targeted sales amount: KRW200b KIMSB Mezzanine trust - KIS IB deals + KIM commodity investments - Investment thesis: Construction loans held by KIMSB - Completed: KRW11.1b (Mar 31 2017) - Target return: IRR 4.5% • M&A financing DLS • Venture fund trust - Investment thesis: - Targeted sales amount: KRW150b Credit-linked DLS KIP Targeted companies sourced by KIS IB - Investment thesis: Venture fund managed by KIP - Expected sales amount: KRW50b (May 2017) - Target return: IRR 10~15% Sales target KRW300b in 2017 Sales target KRW550b in 2017 Source: Company data Source: Company data

Financials

2017. 5. 29

Banks: Valuation matrix (x) KBFG SFG HFG IBK BNKFG DGBFG JBFG Kwangju Total Ticker 105560 KS 055550 KS 086790 KS 024110 KS 138930 KS 139130 KS 175330 KS 192530 KS Recommendation BUY BUY BUY BUY HOLD HOLD HOLD HOLD Overweight Market cap (KRWt) 22.5 23.5 12.6 7.1 3.2 2.0 1.0 0.7 72.6 Current price (KRW) 53,900 49,500 42,550 12,700 9,870 11,900 6,190 12,850 Target price (KRW) 63,000 59,000 47,000 15,800 10,800 14,000 6,800 13,000 Upside (%) 16.9 19.2 10.5 24.4 9.4 17.6 9.9 1.2 FY14 10.1 10.1 9.9 8.3 4.2 6.6 1.1 12.4 8.5 FY15 7.5 7.9 7.7 6.6 4.4 5.8 6.8 6.9 7.1 P/E FY16 7.7 7.7 7.0 6.7 5.6 5.7 6.3 5.4 8.3 FY17E 7.7 8.5 6.9 6.0 5.7 5.9 5.7 5.1 7.4 FY18E 7.4 8.2 6.5 5.6 5.3 5.3 5.3 4.7 7.0 FY14 0.51 0.77 0.45 0.59 0.71 0.52 0.46 0.41 0.59 FY15 0.45 0.65 0.33 0.48 0.38 0.49 0.44 0.31 0.47 P/B FY16 0.52 0.74 0.42 0.48 0.43 0.45 0.43 0.41 0.63 FY17E 0.62 0.76 0.54 0.45 0.47 0.51 0.43 0.45 0.61 FY18E 0.58 0.71 0.50 0.42 0.43 0.47 0.40 0.42 0.57 FY14 3,563 4,388 3,235 1,695 3,454 1,714 5,679 779 FY15 4,396 4,988 3,073 1,875 1,895 1,740 813 1,116 EPS (KRW) FY16 5,549 5,851 4,495 1,888 1,538 1,702 918 2,015 FY17E 7,015 5,837 6,152 2,100 1,718 2,013 1,095 2,534 FY18E 7,330 6,040 6,561 2,257 1,860 2,241 1,169 2,748 FY14 70,660 57,588 71,671 23,977 20,333 21,797 13,188 23,338 FY15 74,213 60,795 72,128 25,560 21,986 20,624 12,480 24,410 BVPS (KRW) FY16 81,756 60,861 73,954 26,631 20,015 21,772 13,376 26,260 FY17E 87,155 65,348 79,366 28,229 21,161 23,484 14,292 28,327 FY18E 92,668 69,875 84,389 29,903 22,761 25,224 15,388 30,570 FY14 0.5 0.6 0.3 0.4 1.2 0.5 2.1 0.2 0.7 FY15 0.5 0.7 0.3 0.5 0.5 0.6 0.3 0.3 0.5 ROA (%) FY16 0.6 0.7 0.4 0.5 0.5 0.6 0.3 0.5 0.5 FY17E 0.7 0.7 0.5 0.5 0.6 0.6 0.4 0.6 0.5 FY18E 0.7 0.7 0.5 0.5 0.6 0.7 0.4 0.6 0.6 FY14 5.2 7.9 4.6 6.8 19.6 8.2 44.7 3.3 7.2 FY15 6.1 8.4 4.3 7.6 9.3 9.2 6.4 4.7 6.8 ROE (%) FY16 7.1 9.6 6.2 7.3 8.3 8.0 7.1 8.0 7.7 FY17E 8.3 9.3 8.0 7.7 8.3 8.9 7.9 9.3 8.5 FY18E 8.2 8.9 8.0 7.8 8.5 9.2 7.9 9.3 8.4 FY14 780 950 600 430 200 320 100 0 FY15 980 1,200 700 450 150 280 50 200 DPS (KRW) FY16 1,250 1,450 990 480 230 300 50 200 FY17E 1,600 1,459 1,480 560 260 500 50 431 FY18E 1,800 1,510 1,640 620 290 560 60 467 FY14 2.2 2.1 1.9 3.0 1.4 2.8 1.6 0.0 FY15 3.0 3.0 3.0 3.6 1.8 2.8 0.9 2.6 Dividend yield (%) FY16 2.9 3.2 3.2 3.8 2.6 3.1 0.9 1.9 FY17E 3.0 2.9 3.5 4.4 2.6 4.2 0.8 3.4 FY18E 3.3 3.1 3.9 4.9 2.9 4.7 1.0 3.6 FY14 21.9 21.6 18.5 25.4 5.8 18.7 1.8 0.0 FY15 22.3 24.1 22.8 24.0 7.9 16.1 6.1 17.9 Payout ratio (%) FY16 22.5 24.8 22.0 25.4 15.0 17.6 5.4 9.9 FY17E 22.8 25.0 24.1 26.7 15.1 24.8 4.6 17.0 FY18E 24.6 25.0 25.0 27.5 15.6 25.0 5.1 17.0 Note: As of May 23 close Source: Company data, Samsung Securities estimates

Financials

2017. 5. 29

Insurance: Valuation matrix Samsung Life Hanwha Life Samsung F&M Hyundai M&F Dongbu Insurance KB Insurance Meritz F&M Ticker 032830 KS 088350 KS 000810 KS 001450 KS 005830 KS 002550 KS 000060 KS Market cap (KRWb) 24,000 5,984 13,890 3,348 4,772 2,022 2,141 Recommendation BUY HOLD BUY HOLD BUY BUY HOLD Target price (KRW) 130,000 7,300 310,000 38,000 76,000 32,000 18,000 Current price (KRW) 120,000 6,890 281,000 37,450 67,400 30,400 19,400 Upside (%) 8.3 6.0 10.3 1.5 12.8 5.3 (7.2) P/E (x) 14A 17.9 14.5 13.8 12.2 8.1 14.2 11.5 15A 19.8 12.0 14.1 14.0 7.8 11.4 7.9 16A 11.3 19.0 13.1 7.1 6.9 6.7 5.4 17E 16.5 11.5 13.2 8.4 9.1 5.6 7.0 18E 16.2 12.5 13.2 8.8 9.5 5.8 7.6 P/B (x) 14A 1.0 0.7 1.0 1.1 0.9 1.0 1.0 15A 0.9 0.6 0.9 1.0 0.8 1.0 0.9 16A 0.8 0.6 0.9 0.9 0.7 0.9 0.8 17E 0.7 0.6 1.0 1.0 1.0 0.7 1.2 18E 0.7 0.6 1.0 0.9 0.9 0.7 1.1 EPS (KRW) 14A 6,687 476 15,754 2,610 5,654 2,312 1,101 15A 6,056 576 15,479 2,274 5,829 2,896 1,617 16A 10,648 363 16,630 4,471 6,641 4,925 2,371 17E 7,265 600 21,224 4,451 7,387 5,433 2,759 18E 7,402 553 21,248 4,256 7,107 5,198 2,563 BVPS (KRW) 14A 117,862 10,483 213,937 28,759 53,130 33,542 13,312 15A 128,550 11,409 232,111 30,534 58,179 34,617 13,934 16A 158,063 10,850 255,966 34,591 62,623 36,625 14,957 17E 170,357 11,679 275,113 38,582 68,149 41,458 16,235 18E 176,943 12,318 293,188 42,404 74,609 45,986 18,147 ROA (%) 14A 0.7 0.5 2.0 1.2 2.1 0.9 1.3 15A 0.5 0.5 1.3 0.7 1.4 0.7 1.2 16A 0.9 0.3 1.3 1.2 1.5 1.1 1.7 17E 0.6 0.5 1.5 1.0 1.5 1.2 1.7 18E 0.5 0.4 1.4 0.9 1.3 1.0 1.5 ROE (%) 14A 6.4 5.3 12.3 14.5 17.6 11.6 12.3 15A 5.3 5.8 8.1 8.6 11.7 9.1 11.9 16A 8.5 3.8 8.1 15.4 12.3 13.1 16.6 17E 5.2 6.2 9.5 13.6 12.6 13.9 17.5 18E 5.0 5.3 8.9 11.8 11.1 11.9 14.8 DPS (KRW) 14A 1,800 180 4,500 750 1,450 500 380 15A 1,800 180 5,150 750 1,550 400 570

16A 1,200 80 6,100 1,350 1,650 600 830 17E 1,950 100 7,200 950 1,490 670 630 18E 2,050 95 7,300 920 1,440 640 590 Dividend yield (%) 14A 1.5 2.6 2.1 2.4 3.2 1.5 3.0 15A 1.5 2.6 2.4 2.4 3.4 1.2 4.5

16A 1.0 1.2 2.8 4.3 3.6 1.8 6.5 17E 1.6 1.5 2.6 2.5 2.2 2.2 3.2 18E 1.7 1.4 2.6 2.5 2.1 2.1 3.0 Payout ratio (%) 14A 25.5 36.0 25.0 25.8 22.9 18.6 35.4 15A 27.5 27.0 28.3 29.4 23.8 13.8 35.1

16A 9.7 19.1 30.8 26.9 22.2 13.5 35.3 17E 25.3 16.7 28.5 19.0 18.0 12.3 23.0 18E 26.1 17.2 28.9 19.3 18.1 12.3 23.2 Note: As of May 23 close Source: Company data, Samsung Securities estimates

Financials

2017. 5. 29

Securities brokers: Valuation matrix Mirae Asset Daewoo KIH NH I&S Kiwoom Securities Mertiz Securities Daishin Securities Ticker 006800 KS 071050 KS 005940 KS 039490 KS 008560 KS 003540 KS Market cap (KRWb) 6,477 3,436 4,170 1,848 2,701 988 Recommendation BUY BUY HOLD BUY BUY BUY Target price (KRW) 12,000 70,000 15,500 100,000 5,200 14,000 Current price (KRW) 9,720 58,500 14,250 83,600 4,460 13,200 Upside (%) 23.5 19.7 8.8 19.6 16.6 6.1 14A n/a 12.5 38.0 13.5 9.6 18.9 15A n/a 9.4 14.1 7.2 6.7 7.6 P/E (x) 16A 125.4 9.7 12.6 8.2 7.0 8.1 17E 15.6 8.6 12.9 8.3 9.2 11.4 18E 13.8 8.2 11.7 7.8 8.8 9.4 14A n/a 1.0 0.7 1.1 1.5 0.4 15A n/a 0.9 0.7 1.2 1.1 0.5 P/B (x) 16A 0.6 0.8 0.6 1.2 0.9 0.5 17E 0.7 0.9 0.9 1.3 1.0 0.5 18E 0.7 0.9 0.9 1.1 1.0 0.4 14A n/a 3,884 270 3,420 412 503 15A n/a 5,266 716 8,585 596 1,569 EPS (KRW) 16A 58 4,542 786 8,142 511 1,481 17E 622 6,839 1,106 10,097 484 1,087 18E 707 7,165 1,217 10,741 508 1,320 14A n/a 48,970 14,596 41,500 2,605 22,154 15A n/a 54,287 15,175 49,913 3,790 24,391 BVPS (KRW) 16A 12,821 57,842 15,497 56,278 4,142 23,973 17E 13,389 62,215 15,714 64,841 4,383 27,133 18E 14,077 68,405 16,341 74,682 4,580 28,238 14A n/a 1.0 0.3 2.3 1.9 0.3 15A n/a 1.1 0.5 3.5 2.3 0.8 ROA (%) 16A 0.1 0.8 0.6 2.4 1.6 0.6 17E 0.7 1.1 0.7 2.4 1.5 0.4 18E 0.8 1.1 0.8 2.3 1.4 0.6 14A n/a 8.7 2.8 11.4 23.9 2.7 15A n/a 10.8 4.8 18.8 22.6 8.1 ROE (%) 16A 0.8 8.3 5.1 15.3 14.1 7.5 17E 6.2 11.8 7.1 16.7 13.5 5.2 18E 6.8 11.4 7.6 15.4 12.2 5.8 14A n/a 700 160 450 290 1,100 15A n/a 1,000 400 700 460 2,100 DPS (KRW) 16A 210 800 400 850 400 2,300 17E 420 1,300 550 820 170 850 18E 504 1,360 590 900 180 1,010 14A n/a 1.4 1.6 1.0 3.7 2.6 15A n/a 2.0 4.0 1.1 5.8 4.2 Dividend yield (%) 16A 0.7 1.8 4.0 1.3 5.6 4.6 17E 2.1 2.2 3.9 1.0 3.8 3.2 18E 2.5 2.3 4.1 1.1 4.0 3.9 14A n/a 17.2 60.2 13.2 30.6 44.5 15A n/a 18.1 56.1 8.2 35.2 26.9 Payout ratio (%) 16A 66.0 17.4 51.1 10.4 35.7 31.3 17E 24.5 18.4 49.9 8.1 32.6 31.8 18E 25.9 18.3 48.6 8.4 32.9 31.2 Note: As of May 23 close Source: Company data, Samsung Securities estimates

2017. 5. 29

Company KB Financial Group (105560)

Update Still rerating

● KB Financial Group has used its deep capital to effect remarkable changes over the past 2-3 years, beefing up its non-banking operations by acquiring a major broker and a non-life insurer. These structural changes should ultimately boost the group’s earnings power. ● After KB Insurance and KB Capital become wholly owned subsidiaries, the market will begin to expect further M&A activities. As rising interest rates and regulatory tightening may put a healthy life insurer on the selling block, it is worth paying attention to whether KBFG shows interest in making another acquisition. Jaewoo Kim ● KBFG remains our top pick, and we expect it to keep rerating on: 1) its sector-high Analyst capital adequacy, which gives it great flexibility in growing its assets; 2) NIM and [email protected] G&A cost-led profitability improvements at its banking operations; and 3) rising 822 2020 7848 earnings contributions from its non-banking business units Eunsoo Lee Research Associate [email protected] 822 2020 7809 WHAT’S THE STORY?

Rerating as immense capital is put to use: KB Financial Group has effected remarkable changes over the past 2-3 years. Superior to its peers in terms of capital AT A GLANCE adequacy, the group has: 1) acquired non-banking financial service providers Woori Financial, LIG Insurance, and Hyundai Securities, which it is turning into wholly owned subsidiaries; and 2) sought to strengthen its non-banking platforms and achieve economies of scope to create more synergies. Such structural changes should ultimately (15.6%) Target price KRW63,000 boost its earnings power. Current price KRW54,500 Market cap KRW22.8t/USD20.3b Full stakes in non-banking subsidiaries to push related profits up steadily: Shares (float) 418,111,537 (84.6%) KBFG on Apr 14 announced that it will acquire all outstanding shares in KB Insurance 52 -week high/low KRW54,500/KRW31,800 and KB Capital via tender offers and share swaps. This is encouraging because it should Avg daily trading KRW58.9b/ value (60-day) USD52.5m allow the group to recognize negative goodwill in 2Q and lead to stronger consolidated net profits from 3Q. Greater earnings contributions from non-banking operations, in turn, ONE-YEAR PERFORMANCE should boost earnings stability and the KBFG’s valuation. 1M 6M 12M KB Financial Group (%) 6.0 29.9 60.8 Further M&As possible: After KB Insurance and KB Capital become wholly owned Vs Kospi (%pts) -0.6 8.9 33.6 subsidiaries, the market will begin to expect further M&A activities, as: 1) completing the full acquisition of these subsidiaries would make it easier for KBFG to manage its KEY CHANGES organization and look to the future; 2) KBFG boasts deep pockets, earning nearly KRW3t (KRW) New Old Diff in net profit each year; and 3) rising interest rates and tightening regulations may put a Recommend. BUY BUY Target price 63,000 63,000 0.0% healthy life insurer on the selling block—a tempting target for KB Life Insurance, which 2017E EPS 7,015 7,015 0.0% needs economies of scale. 2018E EPS 7,330 7,330 0.0% Still our top pick for stability and structural changes: KBFG remains our top SAMSUNG vs THE STREET pick for three main reasons. First, its sector-high capital adequacy gives it great flexibility No of estimates 16 to grow its assets. Second, its banking operation has enjoyed NIM- and G&A cost-led Target price 64,844 improvements in profitability. Third, it plans to fully acquire KB Insurance and KB Recommendation 4.1 Capital, which will allow it to recognize negative goodwill in 2Q, boost consolidated net BUY ★★★ : 5 / BUY: 4 / HOLD: 3 / SELL: 2 / SELL ★★★ : 1 profit from 3Q, and generate more synergies and earnings.

KB Financial Group

2017. 5. 29

Balance sheet Income statement Year-end Dec 31 (KRWb) 2015 2016 2017E 2018E 2019E Year-end Dec 31 (KRWb) 2015 2016 2017E 2018E 2019E Cash & equivalents 16,316 17,885 18,723 19,605 20,533 Interest income 10,376 10,022 11,423 12,218 12,923 Financial securities 49,512 74,091 78,248 82,668 87,371 Interest expenses (4,173) (3,619) (3,653) (3,848) (4,056) Net loans & credits 244,329 264,768 278,549 293,737 309,777 Net interest income 6,203 6,403 7,771 8,370 8,867 Interest-earning assets 310,158 356,743 375,520 396,010 417,680 before provisioning Fixed assets 3,287 3,627 3,765 3,910 4,060 Provisioning for loan losses (1,037) (539) (889) (1,045) (1,107) Other assets 15,620 15,303 16,241 17,243 18,313 Net interest income after provisioning 5,166 5,863 6,882 7,325 7,761 Total assets 329,065 375,674 395,526 417,163 440,054 Fee income 1,535 1,585 1,568 1,644 1,725 Customer deposits 224,268 239,730 251,333 264,268 277,872 Other non-interest income (356) (542) (456) (483) (513) Borrowings 16,241 26,251 27,718 29,276 30,934 Gross profit 6,345 6,906 7,994 8,486 8,973 Debentures 32,600 35,021 36,898 38,889 41,001 G&A expenses (4,524) (5,229) (4,471) (4,692) (4,926) Interest-bearing liabilities 275,978 305,863 321,094 337,882 355,581 Operating profit 1,821 1,677 3,523 3,794 4,047 Other liabilities 24,185 38,549 41,156 43,868 46,873 Other non-operating income 344 952 103 (3) (131) Total liabilities 300,163 344,412 362,250 381,751 402,454 Pre-tax profit 2,165 2,629 3,627 3,791 3,915 Paid-in capital 1,932 2,091 2,091 2,091 2,091 Taxes (437) (438) (878) (918) (948) Capital surplus 15,855 16,995 16,995 16,995 16,995 Net profit 1,727 2,190 2,749 2,874 2,968 Retained earnings 10,464 12,229 14,321 16,458 18,646 Minority interest (29) (46) (39) (42) (45) Capital adjustment 0 (722) (800) (800) (800) Consolidated net profit 1,698 2,144 2,710 2,832 2,922 Other accumulated earnings and Pre-provisioning operating profit 3,055 2,422 4,277 4,684 4,976 430 405 405 405 405 comprehensive income Minority interest 222 263 263 263 263 Shareholder equity 28,903 31,261 33,275 35,412 37,600

Asset quality Year-end Dec 31 (%) 2015 2016 2017E 2018E 2019E Financial ratios NPL ratio (below substandard) 1.2 0.9 0.8 0.8 0.8 Year-end Dec 31 (%) 2015 2016 2017E 2018E 2019E NPL ratio (below precautionary) 2.4 2.1 1.9 1.9 1.9 Return on avg assets 0.5 0.6 0.7 0.7 0.7 Cumulative provisioning Return on avg equity 6.1 7.1 8.3 8.2 7.9 173.1 201.9 223.8 218.6 209.0 /NPL below substandard Loan growth* (% y-y) 5.6 6.4 5.1 5.1 5.1 Cumulative provisioning 85.6 81.2 92.4 90.0 85.9 Deposit growth* (% y-y) 6.0 5.1 4.8 5.1 5.1 /NPL below precautionary Asset growth (% y-y) 5.4 5.8 4.7 4.9 4.9 Cumulative provisioning/credit 2.0 1.7 1.7 1.7 1.6 Loan/deposit ratio* 97.7 99.0 99.0 99.0 99.0 Net write-offs 39.8 51.6 45.2 45.3 45.5 /NPL below substandard Net interest margin** 2.27 2.22 2.32 2.35 2.35 Net write-offs/credit 0.5 0.4 0.4 0.4 0.4 Net interest spread** 1.83 1.97 1.35 1.33 1.32 0.51 0.28 0.33 0.37 0.37 Cost-to-income ratio 61.3 70.2 50.3 49.2 48.9 BIS CAR** 16.0 16.3 16.9 17.5 18.0

Tier-1 ratio** 13.7 14.8 15.5 16.1 16.7 Per-share data Tier-2 ratio** 2.3 1.5 1.4 1.4 1.3 Equity/assets 8.8 8.3 8.4 8.5 8.5 Year-end Dec 31 (KRW) 2015 2016 2017E 2018E 2019E Note: Fully diluted EPS 4,396 5,549 7,015 7,330 7,564 * Won-denominated BVPS 74,213 81,756 87,155 92,668 98,314 ** Based on banking unit (not consolidated) Source: Company data, Samsung Securities estimates DPS (common) 980 1,250 1,600 1,800 1,900

Dividend payout ratio (%) 22.3 22.5 23.0 24.0 25.0

Year-end Pre-prov op prof Net prof EPS Chg BVPS P/E P/B ROAA ROAE Tier 1 Div yield Dec 31 (KRWb) (KRWb) (KRW) (%) (KRW) (x) (x) (%) (%) (%) (%) 2015 3,055 1,698 4,396 23.4 74,213 7.5 0.4 6.1 0.5 13.7 3.0 2016 2,422 2,144 5,549 26.2 81,756 7.7 0.5 7.1 0.6 14.8 2.9 2017E 4,277 2,710 7,015 26.4 87,155 7.8 0.6 8.3 0.7 15.5 2.9 2018E 4,684 2,832 7,330 4.5 92,668 7.4 0.6 8.2 0.7 16.1 3.3 2019E 4,976 2,922 7,564 3.2 98,314 7.2 0.6 7.9 0.7 16.7 3.5 Source: Company data, Samsung Securities estimates

2017. 5. 29

Company Samsung Life Insurance (032830) Update Creating value with capital

● Samsung Life has rallied 11.3% from its ytd low amid a bull market but still trades at just 0.7x 2017 P/B, and still has the opportunity to bolster its fundamentals by altering its portfolio mix or if long-term market yields rise, We maintain BUY on the stock with a KRW130,000 target.

WHAT’S THE STORY? Product-portfolio changes boosting VoNB: Samsung Life is responding to a Sean Chang , CFA maturing protection-type insurance market by changing its product portfolios. The firm Analyst [email protected] reduced the general portion of its protection-type portfolio to 30% in 1Q17 (from nearly 822 2020 7790 60% in 1Q16) while raising the portions of high-margin variable whole life, critical illness, David Lee and lower priced products to 23%, 11%, and 36%, respectively. Accordingly, its protection- Research Associate type APE dipped 32.3% y-y in 1Q17, but its new business margin (NBM) and total value of [email protected] new business (VoNB) grew a respective 4.6%pts and 16.8% y-y to 33.4% and KRW291b. 822 2020 7768 These developments bode well for the longer term, as VoNB will likely emerge as a key valuation barometer for insurers once IFRS 17 standards are introduced in 2021.

AT A GLANCE To gain most from rise in market yields: Boasting a risk-based capital ratio of 313%, Samsung Life is free of capital concerns and should benefit most from a rise in market yields. Guaranteed, high fixed-rate products accounted for 33% of its liabilities in 1Q (Hanwha Life is the only other insurer with a comparable figure [30%] but lacks Target price KRW130,000 (8.3%) Samsung Life’s capital advantages). This resulted in a negative interest spread of 73bps in Current price KRW120,000 March (down 4bps q-q) that equates to an annual loss of KRW500b. However, with Market cap KRW24.0t/USD21.3b market yield highly likely to rise soon—especially in long-term segments, as evidenced by Shares (float) 200,000,000 (41.6%) climbing yields on 10-year US Treasuries—we believe Samsung Life’s unrivalled capital 52 -week high/low KRW123,000/KRW94,800 power will allow it to further differentiate itself. Avg daily trading KRW25.0b/ value (60-day) USD22.3m Discount for inefficient capital utilization to dissipate: The recognizable value ONE-YEAR PERFORMANCE of Samsung Life’s stake in Samsung Electronics has jumped 51.4% as the IT giant's share 1M 6M 12M price has nearly doubled since end-Mar 2016. The KRW5.5t increase represented 21.2% Samsung Life 15.7 7.3 22.0 of Samsung Life’s total equity at end-1Q17, and the company could boost its investment Insurance (%) Vs Kospi (%pts) 8.5 -10.1 1.3 yield by selling some stakes in affiliates in response to the election of a new government and other changes in the environment. The market essentially has not recognized the KEY CHANGES value of Samsung Life’s affiliate holdings, viewing the firm as a de-facto holding company (KRW) New Old Diff for the Samsung Group, so even a small change in governance could act as a significant Recommend. BUY BUY catalyst. We believe the company will soon start to shed a discount for inefficient capital Target price 130,000 130,000 0.0% 201 7E EPS 7,265 7,265 0.0% utilization. 201 8E EPS 7,402 7,402 0.0%

SAMSUNG vs THE STREET

No of estimates 17 Target price 135,941 Recommendation 3.9

BUY ★★★ : 5 / BUY: 4 / HOLD: 3 / SELL: 2 / SELL ★★★ : 1

Samsung Life Insurance

2017. 5. 29

Balance sheet Key ratios Year-end Dec 31 (KRWb) 2015 2016 2017E 2018E 2019E Year-end Dec 31 2015 2016 2017E 2018E 2019E Invested assets 183,082 214,879 226,398 235,467 244,899 Growth (% y-y) Cash & equivalents 3,272 5,823 7,797 6,361 6,616 Total premiums (2.8) 1.6 7.2 3.2 2.3 Securities 137,227 142,071 152,622 156,142 162,497 General account (0.7) (3.6) 4.9 2.0 2.5 Equities 20,046 24,124 22,044 26,718 27,896 Separate account (6.1) 10.3 10.6 5.0 2.0 Bonds 102,748 103,316 114,260 113,358 117,892 Net profit (9.5) 84.0 (30.8) 2.1 1.2 BCs 2,848 3,035 3,178 3,361 3,494 Total assets 19.4 23.4 23.1 11.6 8.6 Foreign securities 10,985 11,129 12,644 12,226 12,715 Invested assets 17.8 24.6 23.7 9.6 8.2 Other securities 599 467 497 480 499 Insurance reserve 15.8 14.1 13.1 12.6 12.4 Loans 33,363 58,063 55,385 63,219 65,649 Total shareholder equity 20.8 27.4 29.0 11.9 9.1 Real estate 9,220 8,923 10,594 9,745 10,137 Premium income mix (%) Non-invested assets 7,695 8,237 9,623 10,099 10,687 Risk premiums 21.1 22.6 21.3 21.5 21.6 Deferred amortization costs 3,856 3,542 7,855 8,261 8,779 Loading premiums 24.7 24.5 23.9 24.1 24.2 Separate account assets 39,586 41,505 47,576 49,883 52,302 Savings premiums 54.2 52.9 54.8 54.3 54.1 Total assets 230,363 264,622 283,598 295,450 307,888 Invested-asset mix (%) Insurance reserve 149,118 158,592 168,586 178,631 189,570 Cash & equivalents 1.8 2.7 3.4 2.7 2.7 Policy reserve 143,389 152,281 163,426 171,879 182,655 Securities 75.0 66.1 67.4 66.3 66.4 Other liabilities 9,976 25,706 35,563 34,011 31,610 Loans 18.2 27.0 24.5 26.8 26.8 Separate account liabilities 40,578 43,857 47,312 49,395 51,604 Real estate 5.0 4.2 4.7 4.1 4.1 Total liabilities 206,641 236,237 253,006 263,675 274,523 Securities mix (%) Paid-in capital 100 100 100 100 100 Stocks 14.5 16.9 14.4 17.0 17.1 Capital surplus 6 63 63 63 63 Money invested 0.1 0.1 0.1 0.1 0.1 Retained earnings 11,567 13,364 14,736 15,919 17,509 Government and public bonds 37.6 37.5 39.0 37.8 37.8 Capital adjustment (1,576) (2,118) (2,118) (2,118) (2,118) Special bonds 31.3 29.8 30.3 29.4 29.4 Other comprehensive income 13,548 15,311 16,146 16,146 16,146 Financial bonds 1.1 0.8 0.9 0.8 0.8 Minority interest 76 1,664 1,664 1,664 1,664 Corporate bonds 2.9 3.7 3.9 4.0 4.1 Total shareholder equity 23,722 28,384 30,592 31,775 33,365 Beneficiary certificates 2.1 2.1 2.1 2.2 2.2 Overseas securities 8.0 7.8 8.3 7.8 7.8 Other 0.4 0.3 0.3 0.3 0.3 Profitability (%) Risk margin 23.2 15.9 19.6 19.8 20.3

Investment yields (A) 3.7 3.3 3.6 3.4 3.6 Average funding costs (B) 4.8 4.5 4.4 4.2 4.3

Claims ratio 59.0 63.5 54.5 54.4 53.1 Income statement Expense ratio 12.8 11.9 11.7 11.4 11.5 Year-end Dec 31 (KRWb) 2015 2016 2017E 2018E 2019E Total premiums 27,457 27,884 29,897 30,864 31,564 General account 17,287 16,669 17,490 17,836 18,275 Separate account 10,170 11,215 12,408 13,028 13,288 Premium income 17,287 16,669 17,490 17,836 18,275 Risk premiums 3,643 3,772 3,727 3,843 3,956 Loading premiums 4,270 4,078 4,174 4,304 4,430

Savings premiums 9,373 8,819 9,589 9,689 9,890 Benefits paid 2,796 3,172 2,996 3,080 3,151 Per-share data Operating expenses paid 3,505 3,305 3,498 3,507 3,614 Year-end Dec 31 (KRW, %) 2015 2016 2017E 2018E 2019E Maturity and surrender payments 7,395 7,415 6,528 6,627 6,549 EPS 6,056 10,648 7,265 7,402 7,485 Net investment income 6,428 7,993 7,505 7,475 8,078 BVPS 128,550 158,063 170,357 176,943 185,802 Changes in premium reserve 9,836 9,193 10,007 10,018 10,938 P/E (x) 18.2 10.3 16.5 16.2 16.0 Total operating income 61 1,364 474 410 353 P/B (x) 0.9 0.7 0.7 0.7 0.6 Non-operating income 1,310 1,343 1,557 1,664 1,745 ROA (%) 0.5 0.9 0.6 0.5 0.5 Effective taxes 162 482 491 502 508 ROE (%) 5.3 8.5 5.2 5.0 4.9 Net profit 1,210 2,225 1,540 1,573 1,591 DPS 1,800 1,200 1,950 2,050 2,150 Net profit attrib. to minority interest (2) 96 87 92 94 Dividend yield (%) 1.6 1.1 1.6 1.7 1.8 Net profit attrib. to controlling interest 1,211 2,130 1,453 1,480 1,497 Payout ratio (%) 27.5 9.7 25.3 26.1 27.0

Note: * Most FY13 figures based on 1Q-3Q; certain valuation and profitability metrics based on 1Q-3Q net profit annualized (fiscal year changed to calendar year in 2014) Source: Company data, Samsung Securities estimates

2017. 5. 29

Company Samsung Fire & Marine (000810) Update Growing dominance should be focus

● Samsung Fire & Marine has underperformed other non-life insurers of late as recapitalization concerns have eased industry-wide and several company-specific factors—which we see as mere noise—have weighed on its shares.

● We believe, however, that investors should focus on the firm's growing dominance, backed by its unrivalled capital power, structural market-share gains in the auto line, and a widening profitability gap in the long-term line. We maintain BUY on the stock with a KRW310,000 target.

Sean Chang , CFA Analyst WHAT’S THE STORY? [email protected] 822 2020 7790 Pullback due to noise: Samsung Fire & Marine has underperformed other non-life David Lee insurers of late, which we attribute to: 1) unexpected cuts to its auto premiums at end- Research Associate 2016; 2) lower-than-expected guidance for 2017; 3) the likelihood of one-off costs in 2H17; [email protected] and 4) the company’s decision to delay a buyback program. We see these issues as mere 822 2020 7768 noise, however, and advise investors to focus on the firm’s growing dominance, backed by its unrivalled capital power, structural market-share gains in the auto line, and a widening profitability gap in the long-term line. AT A GLANCE Structural market-share gains in auto line expected: With auto loss ratios likely haven fallen as far as they can industry-wide, we believe Samsung F&M will keep gaining market share, thanks to an edge in portfolio mix that results in superior profitability. The Target price KRW310,000 (10.3%) company’s auto combined ratio fell to a record 87.4% in March, backed by more exposure Current price KRW281,000 to the high-margin online operation—which has increased market share from 28.6% in Market cap KRW13.3t/USD11.8b December to 31.4% in March thanks to preemptive premium cuts at end-2016. We believe Shares (float) 47,374,837 (65.6%) the firm will keep gaining market share thanks to economies of scale and aggressive 52 -week high/low KRW302,000/KRW252,500 Avg daily trading KRW25.9b/ pricing. Long term, this should play to Samsung F&M’s benefit, much like it did for value (60-day) USD23.0m brokerage firm Kiwoom Securities, which was heavily criticized for slashing online ONE-YEAR PERFORMANCE commissions and threatening the industry, but ended up with a much larger market share. 1M 6M 12M Long-term loss-ratio gaps to widen: Gaps between long-term loss ratios at Samsung Fire & Marine (%) 7.8 -3.2 4.9 Samsung F&M and second-tier players have widened since 2H16 and are likely to Vs Kospi (%pts) 1.1 -18.8 -12.9 continue to do so, as: 1) government measures for medical indemnity insurance appear KEY CHANGES unlikely to trigger industry-wide improvement in ratios; and 2) Samsung F&M has a (KRW) New Old Diff better protection-type portfolio composition and it takes time for new contracts to replace Recommend . BUY BUY old ones. Living-benefit products account for around 55% of Samsung F&M’s protection- Target price 310,000 310,000 0.0% type portfolio, compared to around 65% for second-tier players, and the renewable 201 7E EPS 21,224 21,224 0.0% 201 8E EPS 21,248 21,248 0.0% portion of those products exceeds 75% at Samsung F&M, 10-20%pts higher than at second-tiers. SAMSUNG vs THE STREET

No of estimates 16 Target price 349,600 Recommendation 4.0

BUY ★★★ : 5 / BUY: 4 / HOLD: 3 / SELL: 2 / SELL ★★★ : 1

Samsung Fire &

Marine

2017. 5. 29

Balance sheet Key ratios Year-end Dec 31 (KRWb) 2015 2016 2017E 2018E 2019E Year-end Dec 31 2015 2016 2017E 2018E 2019E Total assets 62,871 67,898 73,456 79,254 85,294 Growth (% y-y) Invested assets 53,408 58,238 62,585 67,257 72,278 Direct premiums written 2.5 2.2 3.0 4.1 3.5 Cash & equivalents 1,358 1,049 1,127 1,211 1,302 Long-term 1.5 (1.0) 1.5 1.8 1.9 Securities 36,118 38,127 40,973 44,032 47,319 Auto 11.6 13.4 8.9 8.1 6.5 Stocks 3,203 3,919 4,211 4,526 4,863 Commercial (11.9) (4.3) (5.0) 9.4 6.5 Bonds 26,625 28,115 30,214 32,469 34,893 Operating profit 37.1 4.6 25.5 0.8 1.4 Beneficiary certificates 1,728 2,360 2,536 2,726 2,929 Net profit (1.7) 7.4 27.6 0.1 1.4 Other 4,562 3,733 4,012 4,311 4,633 Adjusted net profit n/a n/a n/a n/a n/a Loans 14,599 17,878 19,213 20,647 22,189 Total assets 9.1 8.0 8.2 7.9 7.6 Real estate 1,334 1,184 1,272 1,367 1,469 Invested assets 7.4 9.0 7.5 7.5 7.5 Non-invested assets 5,412 5,136 5,973 6,696 7,278 Policy reserve 10.3 8.0 8.5 8.1 7.8 Separate account assets 4,051 4,524 4,897 5,301 5,738 Premium breakdown (%) Total liabilities 52,900 57,017 61,761 66,791 72,052 Long-term 68.5 66.4 65.5 64.0 63.0 Insurance reserve n/a n/a n/a n/a n/a Auto 23.8 26.4 27.9 29.0 29.8 Policy reserve 45,773 49,416 53,621 57,980 62,514 Commercial 7.6 7.2 6.6 6.9 7.1 LT savings prem reserve 38,794 41,941 45,297 48,806 52,456 Profitability (%) Other 6,980 7,475 8,324 9,175 10,059 Loss ratio 84.7 83.9 83.4 83.8 84.2 Catastrophe reserve n/a n/a n/a n/a n/a Long-term 87.5 86.1 85.6 85.5 85.4 Other liabilities 2,884 2,996 3,243 3,510 3,799 Auto 82.4 80.9 80.8 82.4 83.6 Separate account liabilities 4,243 4,605 4,897 5,301 5,738 Commercial 63.7 73.7 71.7 73.4 75.2 Shareholder equity 9,971 10,881 11,695 12,463 13,242 Expense ratio 18.6 19.0 19.6 19.2 19.3 Paid-in capital 26 26 26 26 26 Combined ratio 103.3 102.9 103.0 103.0 103.5 Capital surplus 939 939 939 939 939 Net investment yield 3.3 3.1 3.3 3.1 3.1 Retained earnings 6,795 7,414 8,228 8,996 9,775 Capital adequacy (%) Capital adjustment (1,348) (1,484) (1,484) (1,484) (1,484) Net premiums written/adjusted equity 187.1 175.4 166.5 160.7 155.9 Other comprehensive income 3,558 3,985 3,985 3,985 3,985 Total assets/adjusted equity 620.5 627.1 626.1 632.1 640.1 Policy reserve/net prems written 266.7 279.9 296.7 308.7 321.6

Income statement Year-end Dec 31 (KRWb) 2015 2016 2017E 2018E 2019E Direct premiums written 17,800 18,183 18,722 19,485 20,177 Long-term 12,201 12,077 12,255 12,480 12,718 Auto 4,238 4,804 5,229 5,652 6,017 Commercial 1,361 1,303 1,237 1,354 1,441 Premiums earned 16,956 17,406 18,070 18,796 19,456

Losses incurred 14,364 14,606 15,065 15,752 16,385 Long-term 10,508 10,187 10,246 10,409 10,604 Auto 3,120 3,528 4,008 4,466 4,826 Dividend & per-share data Commercial 736 891 811 876 955 Year-end Dec 31 (KRW, %) 2015 2016 2017E 2018E 2019E Net expenses 3,187 3,347 3,550 3,607 3,752 EPS 15,479 16,630 21,224 21,248 21,539 Increase in catastrophe reserve n/a n/a n/a n/a n/a BVPS 232,111 255,966 275,113 293,188 311,509 Underwriting profit (595) (548) (545) (563) (681) P/E (x) 14.1 13.1 13.7 13.6 13.5 Net investment income 1,677 1,688 1,950 1,980 2,117 P/B (x) 0.9 0.9 1.1 1.0 0.9 Operating profit 1,071 1,120 1,406 1,417 1,437 ROA (%) 1.4 1.3 1.6 1.5 1.4 Non-operating profit (37) (27) (18) 0 0 ROE (%) 8.6 8.3 9.9 9.2 8.7 Pre-tax profit 1,034 1,094 1,388 1,417 1,437 DPS 5,150 6,100 7,200 7,300 7,500 Income taxes 251 253 314 343 348 Dividend yield (%) 2.4 2.8 2.5 2.5 2.6 Payout ratio (%) 28.3 30.8 28.5 28.9 29.3 Net profit 783 841 1,073 1,074 1,089

Year-end Premiums earned Op prof Net prof Loss ratio Exp ratio EPS P/E BVPS P/B ROE Dec 31 (KRWb) (KRWb) (KRWb) (%) (%) (KRW) (x) (KRW) (x) (%) 2015 16,956 1,071 783 84.7 18.6 15,479 14.1 232,111 0.9 8.6 2016 17,406 1,120 841 83.9 19.0 16,630 13.1 255,966 0.9 8.3 2017E 18,070 1,406 1,073 83.4 19.6 21,224 13.7 275,113 1.1 9.9 2018E 18,796 1,417 1,074 83.8 19.2 21,248 13.6 293,188 1.0 9.2 2019E 19,456 1,437 1,089 84.2 19.3 21,539 13.5 311,509 0.9 8.7 Source: Company data, Samsung Securities estimate

2017. 5. 29

Company Korea Investment Holdings (071050) Update Improvements in core operations

● Despite an ongoing bull market, Korea Investment Holdings (KIH) has seen its valuation premium erode.

● Investors should nevertheless focus on the firm’s diversified business structure and the increased competitiveness of securities subsidiary Korea Investment & Securities (which we believe has largely been overlooked).

● Our BUY rating and 12-month target price of KRW70,000 are both unchanged.

Sean Chang , CFA WHAT’S THE STORY? Analyst [email protected] Earnings stability premium waning amid bull market: Despite a years-long 822 2020 7790 industry downturn, Korea Investment Holdings (KIH) has stayed profitable, thanks to David Lee diversification of its business structure, which bestowed it a valuation premium until 2015. Research Associate The stock has been largely shunned by investors since, however, due to mounting [email protected] 822 2020 7768 expectations of a securities industry upturn, with its premium narrowing some after its failed bids to acquire Daewoo Securities and Hyundai Securities.

KIS changing its business model: KIH securities subsidiary Korea Investment & AT A GLANCE Securities (KIS) has altered its business model from an agency type to one that offers differentiated WM products and PI. The broker’s net operating income has also changed its reliance from online/offline retail brokerage commissions and asset management

fees—led by ITC subsidiaries Korea Investment Trust Management Company (KITMC) Target price KRW70,000 (19.7%) and Korea Investment Value Asset Management (KIVAM)—to IB commissions (domestic Current price KRW58,500 real-estate PF deals) and PI operations (direct investments and hedge funds) since 2014. Market cap KRW3.3t/USD2.9b Shares (float) 55,725,992 (72.1%) Non-securities subsidiaries enjoy stable annual profitability: The non- 52 -week high/low KRW58,500/KRW40,050 securities subsidiaries of KIH has enjoyed steady earnings growth, while those of other Avg daily trading KRW6.6b/ value (60-day) USD5.8m subsidiaries are stabilizing on y-y bases (after previously being a discount factor), including at EQ Partners and Korea Investment Partners. Our estimates have the ONE-YEAR PERFORMANCE combined net profit of non-securities subsidiaries hitting at least KRW150b this year, 1M 6M 12M including KRW50b combined from KITMC and KIVAM, KRW30b from Korea Korea Investment 20.3 45.6 40.0 Holdings (%) Investment Capital, and KRW40b-50b from Korea Investment Mutual Savings Bank. The Vs Kospi (%pts) 12.7 22.1 16.3 quarterly earnings of EQ Partners and Korea Investment Partners might show volatility, KEY CHANGES unlike their annual results, which owes to balanced recognition timing. (KRW) New Old Diff Synergies between securities and non-securities subsidiaries to strengthen: Recommend . BUY BUY KIH has focused on boosting the competiveness of KIS by creating synergies among Target price 70,000 70,000 0.0% 2015E EPS 6,851 6,851 0.0% subsidiaries, bolstering the latter’s: 1) asset management operation in 2010 by utilizing 2016E EPS 7,072 7,072 0.0% the two ITC subsidiaries; and 2) real-estate IB operation since 2014 via collaboration with capital and savings bank subsidiaries. KIS recently began offering differentiated financial SAMSUNG vs THE STREET products thanks to the use of affiliates’ networks for deal-sourcing. Steady growth at No of estimates 9 KIH’s non-securities subsidiaries should be seen as increased competitiveness at KIS, Target price 63,556 which should eventually boost the parent’s overall earnings. Recommendation 4.1

BUY ★★★ : 5 / BUY: 4 / HOLD: 3 / SELL: 2 / SELL ★★★ : 1

Korea Investment

Holdings

2017. 5. 29

Balance sheet (KIS) Income statement (KIS) Year-end Dec 31 (KRWb) 2015 2016 2017E 2018E 201 9E Year-end Dec 31 (KRWb) 2015 2016 2017E 2018E 2019E Cash & dues from banks 7,002 7,492 5,454 5,675 5,906 Net commission income 448 453 480 511 527 Securities 18,575 22,301 26,380 27,451 28,566 Brokerage commissions 247 166 168 189 199 Loans 1,779 2,021 2,343 2,438 2,537 BC commissions 62 58 68 70 71 Tangible assets 259 250 256 266 276 Wrap commissions 28 28 28 32 34 Other assets 865 762 985 1,118 1,339 Underwriting commissions 61 87 85 88 88 Total assets 28,480 32,825 35,418 36,949 38,624 Other commissions 49 119 130 132 135 Customer deposit liability 5,232 5,900 3,402 3,540 3,684 Net interest income 367 340 373 388 404 Liability from borrowing 19,317 22,225 26,166 27,229 28,334 Net trading income (20) 7 111 116 114 Other liabilities 636 627 1,542 1,573 1,605 Other net income (0) (35) 1 0 0 Total liabilities 25,185 28,752 31,182 32,417 33,701 Net operating income 795 765 964 1,015 1,045 Paid-in capital 176 176 176 176 176 SG&A expenses 481 465 505 519 529 Capital surplus 1,361 3,053 3,053 3,053 3,053 Labor 305 294 321 330 336 Other reserves 126 130 130 130 130 Other 175 171 184 189 193 Accumulated other comprehensive income 1,632 714 876 1,172 1,563 Operating profit 314 300 460 496 515 Retained earnings 3,295 4,073 4,236 4,532 4,923 Non-operating income 318 306 454 496 515 Non-operating expenses 62 63 95 120 125

Pre-tax profit 256 244 359 376 391 Balance sheet (KIH)

Year-end Dec 31 (KRWb) 2015 2016 2017E 2018E 201 9E Cash and bank deposits 5,856 6,064 5,910 6,165 6,445 Income statement (KIH) Investment securities 19,987 24,260 26,052 27,178 28,410 Year-end Dec 31 (KRWb) 2015 2016 2017E 2018E 2019E Loans 4,066 5,348 5,832 6,084 6,360 Net commission income 597 612 625 666 687 Fixed assets 310 305 308 322 336 Net interest income 446 448 483 502 523 Other assets 1,302 1,341 1,969 2,054 2,147 Net prop trading income (62) (55) 148 108 99 Total assets 31,521 37,318 40,071 41,803 43,698 Other net income 22 (7) (8) 0 0 Customer deposits 4,742 5,378 5,285 5,484 5,694 Net operating income 1,002 998 1,248 1,277 1,310 Borrowings 11,735 13,533 17,369 18,024 18,713 SG&A expenses 618 636 704 718 733 Debentures 1,600 2,710 2,671 2,771 2,877 Operating profit 385 362 544 558 577 Other liabilities 10,273 12,199 10,998 11,413 11,849 Pre-tax profit 417 366 538 558 577 Total liabilities 28,350 33,819 36,323 37,694 39,133 Taxation 93 95 122 123 127 Paid-in capital 308 308 308 308 308 Net profit 324 280 421 441 456 Consolidated capital surplus 603 603 604 604 604 Consolidated retained earnings 2,071 2,292 2,590 2,951 3,407 Consolidated capital adjustments (50) (50) (50) (50) (50) Key growth & profitability indicators Accumulated other comprehensive income 238 225 182 182 182 Year-end Dec 31 2015 2016 2017E 2018E 2019E Total shareholder equity 3,171 3,499 3,748 4,110 4,565 Growth rates (% y-y) Customer deposits 45.0 13.4 (1.7) 3.8 3.8

Total assets 24.4 18.4 7.4 4.3 4.5 Financial ratios & per-share data Total shareholder equity 10.9 10.4 7.1 9.6 11.1 Year-end Dec 31 2015 2016 2017E 2018E 201 9E Net operating income 16.1 (0.4) 25.1 2.3 2.6 Efficiency (%) Net profit 35.6 (16.4) 53.2 4.8 3.3 SG&A expense ratio 160.6 175.8 129.4 128.6 127.0 EPS 35.6 (13.7) 50.6 4.8 3.3 Cost-to-income ratio 143.1 140.4 135.5 138.3 139.6 BVPS 10.9 6.5 7.6 10.0 11.4 Dividends & per share data Profitability (%) BVPS (KRW) 54,287 57,842 62,215 68,405 76,210 Equity turnover 62.2 58.1 47.5 50.2 53.7 EPS (KRW) 5,266 4,542 6,839 7,165 7,401 Return on average assets 1.1 0.8 1.1 1.1 1.1 DPS (KRW) 1,000 800 1,300 1,360 1,410 Return on average equity 10.8 8.3 11.8 11.4 10.7 P/B (x) 0.9 0.8 1.0 0.9 0.8 Operating profit/total assets 1.3 1.1 1.2 1.3 1.3 P/E (x) 9.4 9.7 8.9 8.5 8.3 Dividend payout ratio (%) 18.1 17.4 18.4 18.3 18.4 Div yield (cash, common, %) 2.0 1.8 2.1 2.2 2.3

Year-end Net op revenue Op prof Pre-tax prof Net prof BVPS EPS P/B P/E ROA ROE Divdend yield Dec 31 (KRWb) (KRWb) (KRWb) (KRWb) (KRW) (KRW) (x) (x) (%) (%) (%) 2015 1,002 385 417 324 54,287 5,266 0.9 9.4 1.1 10.8 2.0 2016 998 362 366 271 57,842 4,542 0.8 9.7 0.8 8.3 1.8 2017E 1,248 544 538 415 62,215 6,839 1.0 8.9 1.1 11.8 2.1 2018E 1,277 558 558 435 68,405 7,165 0.9 8.5 1.1 11.4 2.2 2019E 1,310 577 577 450 76,210 7,401 0.8 8.3 1.1 10.7 2.3 Source: Company data, Samsung Securities estimates

Financials

2017. 5. 29

Compliance notice - As of May 26, 2017, Samsung Securities shared group affiliation with Samsung Life Insurance, Samsung Fire & Marine. - As of May 26, 2017, the covering analyst(s) did not own any shares, or debt instruments convertible into shares, of any company covered in this report. - As of May 26, 2017, Samsung Securities' holdings of shares and debt instruments convertible into shares of each company cover ed in this report would not, if such debt instruments were converted, exceed 1% of each company's outstanding shares. - This report has been prepared without any undue external influence or interference, and accurately reflects the views of the analyst(s) covering the company or companies herein. - All material presented in this report, unless specifically indicated otherwise, is under copyright to Samsung Securities. - Neither the material nor its content (including copies) may be altered in any form, or by any means transmitted, copied, or d istributed to another party, without prior express written permission from Samsung Securities. - This memorandum is based upon information available to the public. While we have taken all reasonable care to ensure its reli ability, we do not guarantee its accuracy or completeness. This memorandum is not intended to be an offer, or a solicitation of any offer, to buy or sell the securities mentioned herein. Samsung Securities shall not be liable wh atsoever for any loss, direct or consequential, arising from the use of this memorandum or its contents. Statements made regarding affiliates of Samsung Securities are also based upon publicly available information and do not necessarily represent the views of management at such affiliates. - This material has not been distributed to institutional investors or other third parties prior to its publication.

Target price changes in past two years

KB Financial Group Shinhan Financial Group (KRW) (KRW) 70,000 70,000 60,000 60,000 50,000 50,000

40,000 40,000 30,000 30,000 20,000 20,000 10,000 10,000 0 0 May 15 Nov 15 May 16 Nov 16 May 17 May 15 Nov 15 May 16 Nov 16 May 17

Hana Financial Group Industrial Bank of Korea (KRW) (KRW) 50,000 20,000 45,000 18,000 40,000 16,000 35,000 14,000

30,000 12,000 25,000 10,000 20,000 8,000 15,000 6,000 10,000 4,000 5,000 2,000 0 0 May 15 Nov 15 May 16 Nov 16 May 17 May 15 Nov 15 May 16 Nov 16 May 17

BNK Financial Group DGB Financial Group (KRW) (KRW) 25,000 18,000 16,000 20,000 14,000 12,000 15,000 10,000 8,000 10,000 6,000 5,000 4,000 2,000 0 0 May 15 Nov 15 May 16 Nov 16 May 17 May 15 Nov 15 May 16 Nov 16 May 17

Financials

2017. 5. 29

Target price changes in past two years

JB Financial Group Kwangju Bank (KRW) (KRW) 10,000 14,000 9,000 12,000 8,000 7,000 10,000

6,000 8,000 5,000 4,000 6,000 3,000 4,000 2,000 1,000 2,000 0 0 May 15 Nov 15 May 16 Nov 16 May 17 May 15 Nov 15 May 16 Nov 16 May 17

Samsung Life Insurance Hanwha Life (KRW) (KRW) 160,000 10,000 140,000 9,000 8,000 120,000 7,000

100,000 6,000 80,000 5,000 60,000 4,000 3,000 40,000 2,000 20,000 1,000 0 0 May 15 Nov 15 May 16 Nov 16 May 17 May 15 Nov 15 May 16 Nov 16 May 17

Samsung Fire & Marine Hyundai Marine & Fire (KRW) (KRW) 400,000 45,000 350,000 40,000 300,000 35,000 250,000 30,000 25,000 200,000 20,000 150,000 15,000 100,000 10,000 50,000 5,000 0 0 May 15 Nov 15 May 16 Nov 16 May 17 May 15 Nov 15 May 16 Nov 16 May 17

Dongbu Insurance Meritz Fire & Marine (KRW) (KRW) 90,000 25,000 80,000 70,000 20,000 60,000 15,000 50,000 40,000 10,000 30,000 20,000 5,000 10,000 0 0 May 15 Nov 15 May 16 Nov 16 May 17 May 15 Nov 15 May 16 Nov 16 May 17

Financials

2017. 5. 29

Target price changes in past two years

Mirae Asset Daewoo NH Investment & Securities (KRW) (KRW) 18,000 20,000 16,000 18,000 14,000 16,000 14,000 12,000 12,000 10,000 10,000 8,000 8,000 6,000 6,000 4,000 4,000 2,000 2,000 0 0 May 15 Nov 15 May 16 Nov 16 May 17 May 15 Nov 15 May 16 Nov 16 May 17

Korea Investment Holdings Kiwoom Securities (KRW) (KRW) 100,000 120,000 90,000 80,000 100,000 70,000 80,000 60,000 50,000 60,000 40,000 30,000 40,000 20,000 20,000 10,000 0 0 May 15 Nov 15 May 16 Nov 16 May 17 May 15 Nov 15 May 16 Nov 16 May 17

Meritz Securities Daishin Securities (KRW) (KRW) 8,000 16,000 7,000 14,000 6,000 12,000 5,000 10,000 4,000 8,000 3,000 6,000 2,000 4,000 1,000 2,000 0 0 May 15 Nov 15 May 16 Nov 16 May 17 May 15 Nov 15 May 16 Nov 16 May 17

Financials

2017. 5. 29

Rating changes in past two years KB Financial Group Date 2015/5/26 7/16 10/19 2016/1/28 4/14 9/9 10/13 11/28 2017/1/19 3/13 4/17 Recommendation BUY BUY BUY BUY BUY BUY BUY BUY BUY BUY BUY Target price (KRW) 52,000 49,000 47,000 40,000 42,000 46,000 50,000 55,000 60,000 62,000 63,000 Shinhan Financial Group Date 2015/5/26 7/16 10/19 2016/1/28 4/14 10/13 11/28 2017/1/19 3/13 4/17 Recommendation BUY BUY BUY BUY BUY BUY BUY BUY BUY BUY Target price (KRW) 57,000 55,000 52,000 48,000 51,000 52,000 54,000 57,000 58,000 59,000 Hana Financial Group Date 2015/5/26 7/16 10/19 2016/1/28 4/14 4/22 9/9 10/13 11/28 2017/1/19 3/13 4/21 Recommendation BUY BUY BUY BUY BUY BUY BUY BUY BUY BUY BUY BUY Target price (KRW) 46,000 43,000 35,000 27,000 28,000 31,000 34,000 36,000 40,000 44,000 45,000 47,000 Industrial Bank of Korea Date 2015/5/26 10/19 2016/1/28 10/13 2017/1/19 Recommendation BUY BUY BUY BUY BUY Target price (KRW) 19,000 18,000 14,000 14,500 15,800 BNK Financial Group Date 2015/5/26 10/19 11/18 2016/1/11 4/14 2017/1/19 3/13 4/17 Recommendation BUY BUY HOLD HOLD HOLD HOLD HOLD HOLD Target price (KRW) 21,144 19,222 13,455 10,000 10,500 10,000 10,400 10,800 DGB Financial Group Date 2015/5/26 10/19 11/18 2016/1/28 3/7 4/14 2017/1/19 3/13 4/17 Recommendation BUY BUY HOLD HOLD HOLD HOLD HOLD HOLD HOLD Target price (KRW) 17,000 14,500 13,500 11,000 10,000 10,500 11,400 13,700 14,000 JB Financial Group Date 2015/5/26 10/19 11/18 2016/1/28 4/14 10/13 2017/1/19 4/17 Recommendation BUY BUY HOLD HOLD HOLD HOLD HOLD HOLD Target price (KRW) 9,200 7,700 7,000 6,200 6,400 7,000 6,600 6,800 Kwangju Bank Date 2015/5/26 10/19 11/18 2016/1/28 4/14 10/13 2017/1/19 3/13 Recommendation BUY BUY HOLD HOLD HOLD HOLD HOLD HOLD Target price (KRW) 12,000 9,500 9,500 8,300 10,000 11,000 12,200 13,000 Samsung Life Insurance Date 2015/5/26 2016/1/20 2017/1/31 Recommendation BUY BUY BUY Target price (KRW) 140,000 125,000 130,000 Hanwha Life Date 2015/5/26 8/15 2016/1/20 2/22 7/12 2017/1/31 Recommendation BUY BUY BUY HOLD HOLD HOLD Target price (KRW) 9,000 9,500 8,500 7,300 6,500 7,300 Samsung Fire & Marine Date 2015/5/26 10/25 10/27 2016/1/20 7/12 10/20 2017/1/31 2/16 Recommendation BUY BUY BUY BUY BUY BUY BUY BUY Target price (KRW) 340,000 370,000 380,000 350,000 320,000 350,000 330,000 310,000 Hyundai Marine & Fire Date 2015/5/26 10/25 2016/1/20 7/12 10/20 2017/1/31 4/28 Recommendation HOLD HOLD HOLD HOLD HOLD HOLD HOLD Target price (KRW) 30,000 33,000 32,000 30,000 36,000 34,000 38,000 Dongbu Insurance Date 2015/5/26 8/3 10/25 2016/1/20 7/12 10/20 2017/1/31 4/28 Recommendation BUY BUY BUY HOLD HOLD BUY BUY BUY Target price (KRW) 60,000 65,000 75,000 73,000 70,000 80,000 70,000 76,000 Meritz Fire & Marine Date 2015/5/26 10/25 2016/1/20 4/27 7/12 10/20 2017/1/31 5/25 Recommendation HOLD HOLD HOLD HOLD HOLD HOLD HOLD HOLD Target price (KRW) 13,000 15,000 14,000 15,000 14,500 16,000 15,000 18,000

Financials

2017. 5. 29

Rating changes in past two years Mirae Asset Daewoo Date 2017/1/23 4/26 5/16 Recommendation BUY BUY BUY Target price (KRW) 11,000 10,500 12,000 NH Investment & Securities Date 2015/5/26 8/17 10/12 2016/10/27 2017/1/23 4/26 5/25 Recommendation BUY BUY BUY BUY HOLD HOLD HOLD Target price (KRW) 18,500 13,000 12,000 11,500 12,000 13,000 15,500 Korea Investment Holdings Date 2015/5/26 2016/1/5 2017/1/9 1/23 4/26 5/16 Recommendation BUY BUY BUY BUY BUY BUY Target price (KRW) 90,000 70,000 55,000 57,000 59,000 70,000 Kiwoom Securities Date 2015/5/26 10/12 2016/1/5 5/16 2017/5/25 Recommendation BUY BUY BUY BUY BUY Target price (KRW) 90,000 80,000 75,000 90,000 100,000 Meritz Securities Date 2016/9/19 10/27 2017/4/26 5/25 Recommendation BUY BUY BUY BUY Target price (KRW) 4,500 4,200 4,600 5,200 Daishin Securities Date 2016/9/19 10/27 Recommendation BUY BUY Target price (KRW) 15,000 14,000 Samsung Securities uses the following investment ratings. Company Industry BUY Expected to increase in value by 10% or more within 12 months and OVERWEIGHT Expected to outperform market by 5% or more within 12 months is highly attractive within sector NEUTRAL Expected to outperform/underperform market by less than 5% HOLD Expected to increase/decrease in value by less than 10% within 12 months within 12 months SELL Expected to decrease in value by 10% or more within 12 months UNDERWEIGHT Expected to underperform market by 5% or more within 12 months

Percentage of ratings in 12 months prior to Mar 31, 2017 BUY (82%) | HOLD (18%) | SELL (0%)

Financials

2017. 5. 29

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