Dec. 1 (Bloomberg) -- Just as the legal clouds surrounding Lone Star Funds' three-year effort to sell Korea Exchange Bank lift, the global financial crisis is chipping away at the list of potential buyers.

A Korean court ruled last week that Dallas-based Lone Star's 2003 purchase of Korea Exchange was legitimate, removing a stumbling block that helped topple efforts to sell the nation's sixth-largest bank to HSBC Holdings Plc and Kookmin Bank.

The victory may prove short-lived as the market meltdown prompts chief executive officers to scrap multibillion-dollar acquisitions. South Korea has been hit harder than Asian neighbors by the credit crunch, with the government putting up $130 billion to support banks.

“There aren't any strong buyers out there when all banks are struggling,” said Mo Jae Sung, who overseas almost $1 billion at Hanwha Investment Trust Management Co. in Seoul. “KEB doesn't seem to be an attractive purchase either, given concerns about its deteriorating asset quality.”

Korea Exchange said Nov. 5 that provisions for bad loans almost tripled in the third quarter, causing a 22 percent drop in profit. The company's stock fell 34 percent since Sept. 19, when HSBC, Europe's largest bank, canceled a plan to buy Lone Star's 51 percent stake in the Seoul-based lender. An index tracking 54 Korean financial companies dropped 32 percent in the same period. The stock rose 4.4 percent to 7,530 won at 11:57 a.m. today.

HSBC walked away after waiting a year for Korean regulators to approve the $5 billion transaction -- something they refused to do before the legal dispute was settled.

Credit Freeze

Kookmin, the country's largest bank, and Hana Financial Group Inc., owner of the fourth-biggest lender, have said they're interested in buying Korea Exchange. That was before the bankruptcy of Lehman Brothers Holdings Inc. in September triggered a credit market seizure that sent Korean banks' funding costs higher, prompting the government to guarantee their overseas debt.

At the same time, an economic slowdown has sent bad loans skyrocketing, eroding banks' capital. Macquarie Securities Ltd. forecast on Nov. 26 that South Korea's economy, which expanded 5 percent last year, may shrink 2 percent in 2009. Zurich-based UBS AG predicts the contraction may be as much as 3 percent.

Kookmin's capital-adequacy ratio dropped below 10 percent for the first time since 2001 at the end of September after the bank used 4 trillion won ($2.7 billion) to set up a holding company. At Hana Bank, the ratio slipped to 10 percent from 11.8 percent at the start of 2008.

Yoo's Jail Term

“This is really not the best time for Lone Star to sell KEB,” said Kim Jae Woo, a banking analyst at Samsung Securities Co. in Seoul. “It will be very challenging for Lone Star to win a deal at the right price in this climate.”

For Lone Star officials, controversy surrounding its Korea Exchange purchase has led to more than failed attempts to sell it.

Allegations that Lone Star manipulated the stock price of Korea Exchange's credit-card arm to buy the unit cheaply led to the fund's Korea head Paul Yoo spending five months in jail this year. Yoo, 58, was freed on appeal in June. Lone Star founder John Grayken, who wasn't charged, flew to Seoul to testify for Yoo in January and was questioned by prosecutors. The case awaits a supreme court ruling.

In a separate case where no Lone Star executives were charged, the Seoul Central District Court ruled last week that there was no political conspiracy to sell Korea Exchange at below-market price. Prosecutors are appealing.

Block Sale?

Michael Breen, whose public relations firm represents Lone Star in Seoul, declined to comment. An official at Kookmin's parent KB Financial Group Inc. said the company is still interested in Korea Exchange. A Hana official said the bank is “open to all options for acquisitions.” Both people spoke on condition of anonymity.

Lone Star hasn't given up on the sale. The fund hired Credit Suisse Group AG to find a buyer, replacing Citigroup Inc., which advised it on talks with HSBC.

One alternative for Lone Star, which has already recouped about 75 percent of its $2 billion investment in Korea Exchange through dividends and stake sales, is to sell the stake off in parcels. Yet selling the holding piecemeal may mean forgoing the premium that comes with control of the bank.

Korea Exchange Chief Executive Officer Richard Wacker has opposed block sales, saying in July that the lack of a controlling owner “creates a threat” for the bank.

Even in pieces, Lone Star may struggle to find buyers, said Hanwha Investment's Mo.

“I don't see why any investor would want to take a stake in a Korean bank, whether with or without control, given the risk they may have to pump in more cash,” he said. “There really isn't much more Lone Star can do at this point than simply wait.”

To contact the reporter on this story: Bomi Lim in Seoul at blim30@bloomberg.net

Last Updated: November 30, 2008 22:00 EST