Oct. 30 (Bloomberg) -- Kookmin Bank, South Korea's largest by assets, reported its first quarterly profit decline in almost two years as it set aside more provisions for risky loans and booked fewer one-time gains.

Net income fell 28 percent to 678.1 billion won ($718 million) in the third quarter ended Sept. 30, from 938.6 billion won a year earlier, the Seoul-based company said in a regulatory filing today. Profit, which declined for the first time since the fourth quarter of 2004, fell short of the 726 billion won median estimate of six analysts surveyed by Bloomberg.

Lower profits may add pressure on Kookmin to raise more funds to complete the takeover of Korea Exchange Bank. The deal has been delayed as South Korean prosecutors investigate Lone Star Funds' 2003 acquisition of the nation's fifth-largest bank.

``The figures look okay excluding one-time factors like provisioning costs for bad loans,'' said Song In Ho, who manages about $400 million at Kyobo Investment Management Co. in Seoul. ``Kookmin needs to complete the takeover of Korea Exchange Bank as soon as possible to prepare its future strategies and drive up businesses.''

Operating profit, or sales minus the cost of goods sold and administrative expenses, fell 26 percent to 842.1 billion won.

The company set aside 230 billion won for bad loans in the third quarter, up from 71 billion won in the same period a year earlier. Won-denominated loans rose to 129.5 trillion won as of Sept. 30, from 126.2 trillion won as of June 30, while Kookmin's total assets rose to 198.2 trillion won from 192 trillion won.

Takeover

Kookmin is negotiating whether to extend an agreement to complete the $7.3 billion takeover with Dallas-based Lone Star. The deal, which expired on Sept. 16, remains valid until one or both parties terminate the transaction.

``I think it will be settled smoothly,'' Chief Executive Kang Chung Won told reporters and analysts in Seoul today. ``We are considering various options on how to fund the takeover.''

Korean prosecutors are investigating whether Korea Exchange Bank's financial strength was deliberately understated to allow Lone Star, the biggest foreign investor in Asia's third-largest economy, to acquire the company. A Korean government audit cleared the U.S. buyout fund of any wrongdoing.

Kookmin agreed in March to buy the 70.9 percent stake in Korea Exchange held by Lone Star and state-run Export-Import Bank of Korea. In May, Kookmin said it will pay 15,200 won per share for the acquisition, valuing Korea Exchange at 6.95 trillion won.

Administrative and selling costs surged 22 percent to 81.1 billion won in the third quarter. Kookmin had 89.8 billion won in gains from selling assets in the three months ended Sept. 30, down from 158.1 billion won in the same period last year.

Bad Loans

Bad loans, those on which interest hasn't been paid for more than three months and repayment of principal is deemed unlikely, accounted for 1.33 percent of Kookmin's lending as of Sept. 30, down from 1.98 percent in the same period a year earlier.

Kookmin and other local banks are benefiting as sustained growth in Asia's third-largest economy spurs demand for loans. South Korea's $788 billion economy expanded for a 14th quarter in the three months ended Sept. 30, the longest stretch of growth since the 1997 Asian financial crisis.

South Korean banks boosted third-quarter lending to smaller companies as the government tightened rules on home loans and competition intensified for corporate clients with good credit ratings, a government report showed on Oct. 9. The nation's 18 banks had 291.6 trillion won in outstanding loans to small and midsize companies as of Sept. 30, up 3.9 percent from June 30, the report said.

The country's banking regulator in April tightened lending rules on high-priced apartments in government-designated speculative areas, the third package of measures in nine months to curb property speculation.

Interest Margin

Kookmin's net interest margin, or the percentage of interest income over interest-bearing assets, fell for a second straight quarter to 3.59 percent, down from 3.81 percent in the preceding quarter.

``The figure doesn't look good,'' said Im Dong Pil, an analyst at Dongbu Securities Co. in Seoul. ``It will take some time for Kookmin to improve its net interest margin.''

The margin may decline by 5 basis points to 10 basis points unless interest rates rise, Chief Financial Officer Kap Shin said in a briefing today. A basis point equals to 0.01 percentage point.

Kookmin shares on Aug. 1 posted their biggest drop in more than two months after some analysts raised concerns about the bank's narrowing net interest margin. Any further decline in the third quarter may take another toll on Kookmin's stock price, analyst said.

Deutsche Bank AG cut its 12-month target price for Kookmin shares to 88,000 won from 94,000 won on Aug. 1, and also downgraded its recommendation to ``hold'' from ``buy,'' citing the sliding margin and rising expenses.

Shares of Kookmin Bank closed unchanged at 77,900 won in Seoul. The company reported earnings after the market's close.

To contact the reporter on this story: William Sim in Seoul at wsim2@bloomberg.net

Last Updated: October 30, 2006 04:05 EST