Japanese megabanks face growing domestic credit risk, margin outlook cautious

Japan’s megabanks are facing weakening credit quality of domestic borrowers, in addition to the risk of continued default on their overseas operations, after reporting the highest nonperforming loan ratios in more than three years for the quarter at the end of March.

Mitsubishi UFJ Financial Group Inc., or MUFG, which derives more loan revenue outside of Japan than the other two megabanks, reported the highest NPL ratio of the trio in the fourth fiscal quarter ended March 31. Its bad debt ratio was 1.25%, the highest since the October-December 2017 quarter, and up from 1.00% a year earlier, according to data from S&P Global Market Intelligence. .

However, Sumitomo Mitsui Financial Group Inc., which analysts say has the most exposure to domestic credit card and consumer finance business, reported the largest year-over-year increase in its ratio. of bad debt among megabanks. Its NPL ratio in the fourth fiscal quarter rose to 1.14%, the highest since the January-March 2017 quarter, up 35 basis points from 0.79% a year earlier. Mizuho Financial Group Inc. saw its NPL ratio increase to 1.01%, the highest since the April-June 2017 quarter, from 0.84% ​​for the year-ago period.

“I’m worried because it’s not just an increase in the NPL ratio overseas, it also looks like it’s transformed domestically,” said Morningstar analyst Michael Makdad. “Part of the loan restructuring [that involves] lower interest rates and longer maturities are surely linked to the pandemic and emergency business closures.

Japan’s central government had declared three states of emergency since the pandemic began last year, leading the IMF to expect the country to be among the slowest-growing developed economies in 2021 and 2022. Although business bankruptcies in Japan have tended to fall in recent months, analysts said this could be partly due to government support measures for vulnerable businesses, many of which are facing severe increasing risks of closure if the pandemic persists.

In addition to domestic challenges, Japan’s megabanks are also bracing for the long tail of the recovery in some of their key overseas markets, such as the United States and Southeast Asia.

In the fourth fiscal quarter, MUFG remained the most exposed to potential defaults outside of Japan. Its overseas loan portfolio stood at around $360 billion at the end of March 2021, compared with $268 billion for Sumitomo Mitsui and $264 billion for Mizuho.

High Provisions

While the three megabanks have set aside lower loan loss provisions, or credit costs as they are known in Japan, for the current fiscal year ending March 2022 compared to the prior fiscal year, buffers for potential defaults are still higher than pre-pandemic levels.

MUFG, for example, plans to cut loan loss provisions for the current fiscal year to 350 billion yen from 515.5 billion yen in the previous fiscal year. However, it will still be higher than the 222.9 billion yen in provisions for the fiscal year ending March 2020, before the pandemic spread to most parts of Japan.

“Banks’ borrowing costs are still high, which means they are preparing for default risks,” said Toyoki Sameshima, principal analyst at SBI Securities Co. “I will not rule out the possibility that loan ratios non-performing increase further.”

Cautious margin outlook

All three megabanks posted quarter-over-quarter growth in net interest margins for the January-March quarter, the first time in a year. However, on a yearly basis, MUFG’s margin was even lower, while Mizuho’s margin saw the biggest increase.

The rally in NIM, a key measure of profitability, from the previous quarter was largely due to higher interest rates that banks were charging struggling businesses through government subsidies to such borrowers, analysts said.

“What would happen to their margins in the future?” Sameshima said. “They could become stable for the big banks as it is uncertain whether the demand for new loans will increase further under the pressure of low interest rates. [on lenders] stay solid. »

Japan’s economy is expected to grow 3.3% in 2021 and 2.5% in 2022, the weakest among developed countries, according to IMF data. Estimates for the world’s third-largest economy are lower than projections of 6.0% and 4.4% for global economic growth over the next two years.

“Obviously, their default risks will continue to increase if the government ends financial support [for struggling businesses]”, said Takahide Kiuchi, executive economist at the Nomura Research Institute. “If so, their highest [net interest] the margins could also be short-lived.

As of May 21, US$1 equaled ¥108.95.

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