Fitch sees another dull year for Japanese banks

Agency expects no immediate change in ratings as lenders' profitability expected to remain weak in FY2011.

Fitch Ratings has commented in a newly published special report that performance of major Japanese banking groups will remain lacklustre in the fiscal year to end-March 2011 (FYE11). The agency therefore does not expect any immediate change in their ratings, although the situation may vary from bank to bank, according to a Fitch Ratings report.

In FYE10, all major Japanese banks saw profitability recover from the particularly challenging year in FYE09, when most of them posted net losses. However, extending the profit growth momentum into FYE11 will be unlikely, with the banking groups forecasting profit levels to be similar to that of FYE10. Fitch expects profitability from core operations to remain weak in FYE11, with a small decline in loan loss charges to support a modest improvement in net profits.

Fitch does not expect any large issuances of common stocks from major banks over and above the potential issuance that Mizuho Financial Group (Mizuho) has already registered. This is because the banks' low profitability will be unable to withstand additional dividend payouts, and the market having already absorbed repeated issuances before end-FYE10 may have a low appetite for additional issuance. Therefore, the agency believes the accumulation of retained earnings to be the primary way to strengthen the banks' core capitalisation. However, given the likely weak profitability of the banks, Fitch does not anticipate a material bolstering of core capitalisation, and these factors combine to limit the possibility of an immediate upgrade to their ratings.

Fitch notes that a potential weakening of loan quality is a down-side risk for these major banks. Although loan quality has remained sound on the surface, Fitch remains concerned that a large portion of loans exempted from being categorised as non-performing loans (NPLs) under government initiatives, may eventually become NPLs, should the economy remain subdued and restructuring efforts fail to significantly improve the borrowers' financial health. The direct impact from sovereign credit concerns in parts of Europe are expected to be limited, although it may affect the banks indirectly via weakening performances of Japanese companies relying on exports to European markets and/or a decline in stock prices.

As there are limited lending opportunities in both domestic and overseas markets, the major banking groups are increasing their investment in the Japanese government bonds (JGBs). However, since near-term prospects for interest rate hikes in Japan are minimal, the risk related to JGB investments will be limited. That said, interest rate risk may increase in the medium-term.

Fitch views the major banking groups' reduction in stock investment exposure positively. However, as the banks appear to have sold stocks with lower acquisition costs, the investment portfolios of these banks break-even on average when the Nikkei index breaches the 9,000 mark at end-FYE10, as compared to 8,000 at end-FYE09.

The six major Japanese banking groups are Mizuho ('A'/Stable), Sumitomo Mitsui Financial Group ('A'/Stable), Mitsubishi UFJ Financial Group (MUFG), Chuo Mitsui Trust Group, Sumitomo Trust & Banking Company ('A'/Stable) and Resona Holdings.