Our ratings on Hachijuni Bank Ltd. (A/Stable/A-1) reflect its strong capitalization, adequate liquidity supported by solid small-lot deposits, and strong business franchise in Nagano Prefecture. On the other hand, the ratings are constrained by weak profitability considering the high ratings we have assigned to the bank, as well as the interest rate risk volume in its banking book, which we view as large relative to its capital and earnings and by international standards.
Standard and Poor's bases its ratings on Hachijuni Bank on the bank's "adequate" business position, "strong" capital and earnings, "adequate" risk position, "average" funding, and "strong" liquidity. The bank's stand-alone credit profile (SACP) is 'a'.
Our bank criteria use our Banking Industry Country Risk Assessment (BICRA) economic risk and industry risk scores to determine a bank's anchor SACP, the starting point in assigning an issuer credit rating (ICR). Our anchor SACP for a bank operating only in Japan is 'a-'. The BICRA score is informed by our evaluation of economic risk. We view Japan as a developed and diverse economy with a strong net external balance, which offsets the high level of government debt, and limited fiscal flexibility. With regard to industry risk, the banking sector is underpinned by a high and stable share of core deposits in funding and prudent regulatory monitoring. On the other hand, we consider the banking sector as fragmented with overcapacity, and those factors are evidenced by generally low earnings capacity.
Standard & Poor's assesses Hachijuni Bank's business position as "adequate," based on the bank's solid customer base in its home prefecture of Nagano, which has a vibrant manufacturing industry (particularly in the machinery industry). With JPY6.6 trillion in total assets as of March 31, 2012, the bank is ranked among the top 10 of 64 Japanese regional banks on a stand-alone basis (excluding groups), placing it at the top of domestic banks with head offices in Nagano, whose GDP is almost equal to that of Morocco. The bank boasts a 41% share of loans and a 32% share of deposits (as of March 31, 2011) in the Nagano Prefecture market, far ahead of the competitor with the second-largest market shares. This has allowed the bank to maintain a stable earnings base over a long period of time. Seen against the entire domestic market that includes major banks, however, its customer base appears limited. Its operating base is also highly concentrated in Nagano Prefecture. Against this backdrop, the bank maintains a conservative management policy and focuses on retail lending, particularly loans for small and midsize enterprises (SMEs) and residential mortgage loans for mainly individual customers.
Standard & Poor's assesses Hachijuni Bank's capital and earnings as "strong," based on the view that the bank's capital base is strong, while its profitability is slightly weak by international standards. We expect its risk-adjusted capital (RAC) ratio to remain high, in the range of 11.0% to 12.0% in the next 18 months or so. As for profitability, however, the bank's net core operating profit, a financial measure to indicate its fundamental earnings capacity, may decrease slightly for the foreseeable future, in our view. There is limited demand for bank loans in Japan and spreads are narrowing, reflecting intense competition in the banking industry.
The Small and Midsize Enterprises (SMEs) Financing Facilitation Act, which has bolstered the credit quality of SMEs, is set to expire in March 2013. Given that loans to SMEs generally account for a high percentage of credit extended by regional banks, Hachijuni Bank's nonperforming loan (NPL) ratio may increase to some extent, thereby raising credit costs in the next 18 months or so. Our base-case scenario for the bank incorporates the risk that the NPL ratio may increase about one percentage point, mainly due to the expiration of the SME Financing Facilitation Act. Taking into account the bank's coverage ratio of NPLs under our base-case scenario, we believe that incremental credit costs will be limited. However, the bank's asset quality could deteriorate further. The earnings of its corporate customers could fall if growing uncertainties in the global economy significantly slows domestic growth. In particular, we will closely monitor how changes in economic conditions would affect the bank's asset quality, given that SMEs are regional banks' core customers and are more susceptible to such changes than big corporations.
Our "adequate" assessment for Hachijuni Bank's risk position reflects our view that the bank is likely to maintain the risk position and risk asset volume of its loan portfolios over the next one to two years. That will enable the bank to sustain its adequate risk management system. As of March 31, 2012, the bank's net NPL ratio (consolidated risk-managed assets net of loan loss provisions) to total loans stood at 1.9%, which is average for rated regional banks. In the past five years, its credit cost ratio exceeded Standard & Poor's normalized loss levels twice--once in fiscal 2007 (ended March 31, 2008) when the bank disposed NPLs of large-ticket borrowers and another in fiscal 2008 (ended March 31, 2009) when the economy took a hit from the collapse of Lehman Brothers Holdings Inc. However its loan portfolio comprising small-lot deposits (centered on loans for SMEs and residential mortgage loans for mainly individual customers) is generally stable compared with those of major banks. Meanwhile, its investment banking and trading businesses are limited, and thus, the degree of operational complexity is low. By market comparison, however, its net profits are more susceptible to interest rate fluctuations, given that bonds account for a higher proportion of its asset portfolio.
We assess Hachijuni Bank's funding as "average" and its liquidity as "strong." The main funding source is a stable base of core deposits consisting of small-lot deposits. Backed by its solid customer base, Hachijuni Bank secures a high level of deposits, which cover all the lendable funds of the bank (its loan-to-deposit ratio stood at 73% as of March 31, 2012). Therefore, the bank is not directly affected by changes in the funding market environment. In addition, the bank has not issued corporate bonds and invests excess funds in assets with relatively high liquidity, such as Japanese government bonds. It has a stable deposit base that generally consists of small-lot deposits mainly from individual accounts (in Nagano Prefecture), which make up about 65% of its total deposit balance.
Standard and Poor's assesses the likelihood of extraordinary government support for Hachijuni Bank in a time of need as "moderately high." This reflects our view that the bank has "moderate" systemic importance in Japan and the government's "highly supportive" tendency toward private-sector banks in Japan. Our assessment is based on Hachijuni Bank's position in the domestic market, Japan's legal framework of government support for domestic banks, including the capital injection scheme, and the government's track record of providing support for regional financial institutions. Nevertheless, the counterparty credit rating on Hachijuni Bank is 'A', which is on par with the bank's SACP, even after factoring government support into the rating. This is because Hachijuni Bank's SACP is lower than the sovereign rating on Japan (AA-/Negative/A-1+) by merely two notches, leaving little room for a notch-up for the likelihood of government support. Under our rating criteria, if the likelihood of extraordinary government support is "moderately high," no notch-up is incorporated into the rating for a combination of 'a' SACP and the current 'AA-' sovereign rating on Japan.
Related Criteria And Research
Banks: Rating Methodology And Assumptions, Nov. 9, 2011.
Banking Industry Country Risk Assessment Methodology And Assumptions, Nov. 9, 2011