Japanese mega banks' asset quality could be in danger, warns analyst

Blame it on exposure to troubled electronics manufacturers.

According to Fitch Ratings, Japan's three mega banks may increase their exposure to troubled electronics manufacturers, putting pressure on asset quality. The banks' strategies to counter the stagnant domestic market, including by rapid offshore expansion, may also add to this pressure in the longer term, especially if the banks' risk appetite grows. This adds to the challenges that reduce the potential for upgrades to the banks' Viability Ratings, but on its own is unlikely to be enough to trigger VR downgrades.

Here's more from Fitch:

The mega banks already have exposure to some of the electronic companies and we believe they could increase this exposure (among other options) to help revitalise the major manufacturers' operations. The strong yen and reduced demand from China are weakening the financial profiles of manufacturers, exerting pressure on banks' asset quality.

The subdued yet intensely competitive domestic economy in Japan has prompted the mega banks to expand rapidly in offshore markets or take on larger - and arguably riskier - exposures, such as funding the acquisition of Sprint Nextel Corp by Softbank. Offshore expansion may result in higher risk profiles, if this is prioritised to offset narrow domestic margins without appropriate risk-based pricing.

While figures on lending to individual companies are not disclosed, 11% of total loans at Mitsubishi UFJ Financial Group and Mizuho Financial Group were to the manufacturing sector and at Sumitomo Mitsui Financial Group, the figure was 10% at end-March 2012. The banks also have equity exposure to the major Japanese electronics manufacturers including Sharp, which we downgraded to 'B-' from 'BBB-' on Friday, reflecting growing risks to its profitability and capitalisation.

We would not expect increased exposure to the electronics sector to have enough impact on overall asset quality to warrant downgrades of any of the three banks. Overall loan growth has been modest despite rapid offshore growth (aggregate offshore investment accounts grew by 14% yoy in FYE12, which was 17% of their total assets). Aggregate net non-performing loans of the three banks were also just 9% of Tier 1 capital at the end of March.