Why we are not too hot about Kbank

Kbank will start building the book for the IPO this week. In its IPO filing, Kbank applied a PBR of 2.56 to come up with the offering price. 

The average PBR of KB Financial Group, Shinhan Financial Group, and Hana Financial Group is about 0.5 times. So basically Kbank is making a claim that it deserves a valuation multiple that is 5 folds higher than the three leading banks.

In order to justify a higher valuation multiple, the bank needs to demonstrate that its normalized ROE is much higher and has a great growth profile for a very long time.  

However, Korean internet banks are inherently not too different from the bricks-and-mortar banks. It would be extremely difficult for Kbank to show higher profitability than the three leading banks anytime in the foreseeable future if not forever. 

The internet banks do not have physical branches that incur huge expenses. However, other than Kakao Bank, which was built on the messaging platform ‘Kakao Talk’ that the entire population uses everyday, no other internet bank has the access to low-cost deposits. Koreans keep their demand deposits with the larger bank that has physical branches. 

That said, Kbank relies 100% on savings accounts for funding other than Upbit (cryptocurrency exchange) deposits, which only cost 0.1% for Kbank. Upbit user deposits, which were the only low-cost funds, will not cost a lot more due to the ‘Virtual Asset User Protection Act’. Kbank will now have to pay 2.1% on Upbit deposits. Already, the profitability of Kbank fell sharply in July and August. Excluding one-offs Kbank's ROE fell to 1% level. 

Kakao Bank’s low-cost deposit portion of total is 57%. Even with the lower funding cost Kakao Bank’s ROE was only 6% in 2023. The market expect its ROE to improve to 8.44% in 2026 when the excess capital issue is resolved to some extent. 

The normalized ROE level of leading Korean banks is roughly 8% plus. Given that Kbank’s advantages of not having a bricks-and-mortar cost base is washed away by having higher deposit cost even if the bank achieves the economies of scale the banks will not likely have much higher ROE than the offline banks. 

If not the profitability, the high valuation must be justified based on growth potential. But the growth may actually slow down sooner than expected. Structurally, it is difficult for Korean internet banks to grow rapidly because of the requirement of maintaining a 30% subprime credit loan portfolio portion. 

The Korea financial regulator requires internet banks to lend 30% of its assets to individuals with lower credit ratings. Given that the credit cost of retail subprime credit loans fluctuates dramatically and may rise to unsustainable levels during the financial crisis it would be almost impossible to grow iter at a rapid pace. 

Intensifying competition in the online lending market is also likely to limit its growth potential. The regional banks are already making inroads into the Seoul metropolitan area through online lending. Savings banks are also active in online lending. In addition, the government is preparing to launch the fourth internet bank. 

The reason internet companies receive higher valuation multiples is because they do not need capital for growth. Even if capital-intensive companies have growth opportunities, they cannot grow if they do not have the capital. 

Banks with a high percentage of fee income have a relatively lower capital requirement for growth. This means they deserve a higher valuation multiple. However, Kbank is losing money on the fee front. The bank’s fee income comes mostly from the Upbit users, which is highly correlated with the cryptocurrency trading volume, which is on the decline.  

Structurally, Korean internet banks profitability cannot surpass that of offline banks due the higher funding cost with an exception of Kakao Bank, which was built on KakaoTalk used by the entire population. That said, why is Kbank asking the market to pay 2.56 times?