TEXT-Fitch: Forbearance Masks Credit Risks For Japan's Regional Banks

Mon Nov 19, 2012 7:57pm EST

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(The following was released by the rating agency)

LONDON/TOKYO/SINGAPORE, November 20 (Fitch) Restructured loans are unlikely to decline as the expiration of the Japanese government's forbearance measures approaches, Fitch Ratings says. We are concerned that restructurings under the forbearance policy have masked the build-up of credit risk for the regional banks, especially as we see some near-term challenges for the Japanese economy.

Corporate bankruptcies have been rather subdued since the enforcement of the Act Concerning Temporary Measures to Facilitate Financing for SMEs in December 2009, and the regional banks have benefitted from declining loan-impairment charges. We believe that non-performing loans and credit costs will stay artificially depressed in the short-term, but could rise in two to three years as the banks adjust to a more disciplined approach to loan classification.

We expect most restructured loans to remain classified as performing when the Act expires at the end of March 2013. The forbearance measures allow loans to be rescheduled and avoid classification as non-performing. Japan's Financial Services Agency recognises the need to ensure greater risk management discipline, but we expect it will maintain a flexible stance towards bank loan classification in order to prevent a disorderly adjustment. Forbearance is likely to remain high in the short term.

Regional banks' credit quality remains a source of concern, particularly as the Japanese economy contracted by an annualized rate of 3.5% in July-September this year. Any deterioration in asset quality, together with less of an inclination to apply forbearance, may place greater pressure on earnings.

Weak market conditions and intense competition from the mega banks and other regional financial institutions have depressed revenues for the regional banks. We believe that regional banks' profitability is going to be more susceptible than ever to Japan's prospects for economic recovery, and also the way in which they wean themselves off restructurings. These pressures could encourage the regional banks to overcome the many operational and political obstacles to consolidation in the longer term.

For the mega banks, we believe the expiry of the forbearance measures can be managed more comfortably. Their strong franchises, expanding overseas operations as well as asset quality which is still sound, will support a moderate level of profitability in the face of tough domestic conditions.

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