Oct. 31 (Bloomberg) -- Shinhan Financial Group Co., which controls South Korea's third-biggest bank, posted a bigger-than- expected drop in third-quarter profit, and Hana Financial Group Inc. had its first quarterly loss as they made more provisions for bad loans.

Shinhan's net income fell 38 percent to 323.3 billion won ($255 million) in the three months ended Sept. 30 from 524.2 billion won a year earlier, the Seoul-based company said today in an e-mailed statement. That compares with the median estimate of 503.5 billion won by six analysts surveyed by Bloomberg News.

Shinhan and its local rivals face an increasing risk of defaults on loans amid concerns South Korea may be headed for its first recession since it sought an International Monetary Fund bailout 10 years ago. The Bank of Korea on Oct. 27 slashed interest rates by a record 75 basis points as Asia's fourth- largest economy grew at the slowest pace in four years.

``Shinhan has been aggressive in increasing loans in the past year, which may come back to haunt them,'' said Mo Jae Sung, a fund manager who helps oversee an equivalent of $995 million at Hanwha Investment Trust Management Co. in Seoul. ``How much their asset quality deteriorates is the key thing to watch out for all banks in the coming quarters.''

Hana, controlling the nation's fourth-largest lender, posted a net loss of 73.3 billion won, the first since it was set up in December 2005, after it set aside 250.7 billion won in extra provisions against losses from sales of currency options.

KIKO Losses

The Seoul-based company's main Hana Bank unit assumed 286 billion won in valuation losses when Taesan LCD Co., which bought so-called knock-in knock-out contracts from Hana, filed for court protection last month under mounting losses from the options.

The KIKO options, which exporters bought as a hedge against the appreciating won, turned into losers as the won depreciated 28 percent against the dollar this year, performing worst among Asian currencies.

Shinhan fell 5.2 percent to 31,300 won in Seoul trading today before earnings were posted. The stock dropped 42 percent this year on concerns Korean banks will have difficulty refinancing debt after the global credit crunch has driven the cost of funding higher. Hana lost 5.2 percent, extending this year's decline to 60 percent.

Korean banks are set to receive $100 billion in state guarantee that would cover about 140 percent of their external liabilities due by mid-2009. Lenders were also given access to $30 billion of the government's dollar holdings.

Bad Loans

Shinhan set aside 294.3 billion won in provisions in the third quarter, up from 18.3 billion won a year ago, as more bank loans turned sour. Shinhan's non-performing loan ratio rose to 1.06 percent from 0.98 percent a quarter ago.

The bad loan ratio at the company's main Shinhan Bank unit grew 9 basis points to 0.87 percent from a quarter earlier, with the delinquency rate rising to 0.69 percent. A basis point is 0.01 percentage point.

Hana Bank's non-performing loan ratio also rose 18 basis points to 0.9 percent, as more loans turned bad in both corporate and household sectors.

The government has taken a series of measures to avert an economic slowdown, including an 8 trillion won package to support the construction industry. An index measuring manufacturers' confidence for November sank to a record low, the central bank said today. Factory production fell for a third month, the statistics office said today.

``It will be a while until government measures start to calm market jitters over a potential rise in defaults on loans,'' said Park Seong Min, head of equities at LS Asset Management Co. in Seoul, which manages the equivalent of $500 million in equities.

Shinhan Bank's net interest margin, a measure of profitability from lending, gained 7 basis points to 2.1 percent. Hana's margin shrank four basis points to 2.01 percent, falling for the third straight quarter.

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

Last Updated: October 31, 2008 04:11 EDT