It's early days, but speculation is already building that HSBC <0005.HK> may participate in the auction for a $3.9 billion stake in Korea Exchange Bank <004940.KS>, South Korea's sixth-largest lender.

Domestic lender Kookmin and fourth-ranked Hana Financial Group <086790.KS> are widely expected to place bids for the 51 percent stake that U.S. private equity firm Lone Star officially put back on the block last week. State-run Korea Development Bank may also bid, according to investment bankers and analysts.

What would make the auction interesting, however, is if a foreign bank took part in the process, adding a cross-border element and possibly bidding up the asking price along the way.

At the moment, the bank most likely to fill that role appears to be HSBC, which announced a deal, that eventually failed, to buy the Lone Star stake in September 2007. Local media reports have said HSBC was courting KEB even in 2005, when Kookmin was working on a deal to buy KEB, which also failed.

HSBC is not commenting on the matter.

While HSBC, Europe's biggest bank, may be tempted to fill a gap in its Asian holdings by pursuing KEB once again, Basel III capital reform and other regulatory changes could deter it from big deals and instead force it keep its powder dry until the landscape is clearer.

Still, HSBC's head of South Korean operations, Matthew Deakin, has previously hinted that he's on the lookout. He told reporters last October the bank was always open to interesting offers, adding: Right now, we have no interest. But the world is changing.

Investment bankers say it's too early to identify any affirmative bidder and any deal, if it succeeds, could slog through the remainder of the year.

Confidence about any sale being completed is not exactly high either, as two deals for KEB have failed before.

And while Lone Star's effort to exit KEB is one of Asia's most infamous M&A sagas, it still represents a huge opportunity for a foreign bank hoping to expand into Asia's fourth-largest economy.

Acquiring a bank is the quickest way for an outsider to get established in South Korea's competitive but potentially lucrative market for financial services, including retail banking and asset management.

Citigroup and Standard Chartered became major players by buying domestic rivals in South Korea.

KEB has over 5.4 million deposit customers with over 350 branches and a presence in 18 countries, making it Korea's leading international bank.

Macquarie estimates KEB's value as an M&A target would fetch a premium of 20-40 percent from the current market price, or 17,000-20,000 won apiece. That compares with Kookmin Bank's offer of 15,400 won in 2006 and HSBC's bid at 18,045 won in 2007.

But KEB is already one of the most expensive stocks among Korean banks, trading at 1.3 times book value, versus the sector average of 0.8 and 1.2 times for the country's top financial services firm Shinhan Finance <055550.KS>, according to Thomson Reuters data.

GOOD FIT

KEB has particular strengths in trade finance and foreign exchange, complementing HSBC's global capabilities in these areas, HSBC said in 2007.

HSBC has strengthened its Asia focus since the failed 2007 agreement with KEB, moving its CEO Michael Geoghegan to Hong Kong this year. Unlike StanChart and Citi, HSBC has a relatively small presence in South Korea.

HSBC first tried to buy a Korean bank during the Asian financial crisis in the late 1990s. Its bid to buy nationalized Seoulbank, which was later bought by Hana Bank, faltered in 1999 due to differences over how to value its loan book.

Since HSBC walked away from its $6.3 billion offer for the majority of KEB in late 2008 amid a global credit crisis, it had denied its interest in the Korean lender. HSBC may well indeed not be interested. But then again, it does say it's looking for opportunities in Asia.

This is the last time a foreign bank will have this kind of opportunity in Korea... HSBC would think long and hard before saying 'no,' said an investment banker in Hong Kong.

Analysts doubt if the stake sale can take place as early as the first half of the year, as Lone Star expects, because it coincides with an effort by the South Korean government to offload a 7 percent stake in third-ranked Woori Finance Holdings <005300.KS>.

The preference is to space out the processes, sources say, rather than bunch the deals together.

If it is foreign capital (that buys KEB), the sale could be done quickly, said Joanne Lee, an analyst with Shinhan Investment Corp.

But if Lone Star wants to include KB, Hana and other local bidders in an auction, it will be difficult to see the sale done in the first half.

KB Financial Group <105560.KS> , the parent company of top domestic bank Kookmin, is viewed as one of the strongest candidates to buy KEB, as it has 6.5 trillion won ($5.7 billion) in excess capital, but a prolonged vacancy in top management could mean slow execution in transforming M&A deals.

Analysts say Lone Star would prefer to offer its majority stake in KEB in an auction to fetch a 20 percent plus premium.

But sources say that because Lone Star has already recouped the $1.2 billion it paid for the stake, a 'Plan B' would be to gradually sell down its stake in the open market through block sales. But sellers normally push for an acquisition premium.

Given the fact that Korea will host the G20 (summit) meeting this year, political influence on the KEB deal would likely be minimized, said Chan Hwang, head of research at Macquarie in Seoul.

Hence ... we cannot rule out the possibility that foreign banks could be a candidate for acquiring KEB.

(Additional reporting by Steve Slater in LONDON, Editing by Muralikumar Anantharaman)

South Korea Investment HSBC