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Feb 5 (Reuters) - (The following statement was released by the rating agency)
Japanese banks are unlikely to sustain their strong profit run this year, says Fitch Ratings. This is because recent Abenomics-related gains can be attributed to a spike in optimism rather than fundamental improvements, as sluggish core lending conditions prevail. A firmer yen and growing emerging-market uncertainties are likely to weigh on earnings prospects.
The monetary authorities are widely expected to maintain an accommodative policy stance, but financial conditions are unlikely to provide as much scope to boost earnings as last year. This is in line with our longstanding view that Abenomics was bound to boost banks’ earnings, but only temporarily.
A major drag on banks’ profitability will arise from ongoing pressures related to core lending operations. Notwithstanding recent anecdotes of rising property prices or real wages in the Tokyo metropolitan area, the private sector and SMEs have yet to generate sufficient loan demand. Even if demand were to pick up, lending margins should continue to be squeezed - as was apparent from the decline by 2bp, to 1.15% in the last quarter.
The implementation of a higher consumption tax in April is also expected to dampen spending and retail loan demand. A short-term spending stimulus - to offset the adverse effects of the consumption tax hike - may provide some respite. Nonetheless, a sustained pick-up in loan demand, and firmer margins, remains in doubt.
Profits from non-core activities such as equity investments are also likely to come under pressure. A weaker yen was a key driver of higher equity prices in 2013, but the value of the yen has stabilised after weakening by 21%. If this condition persists, Japan’s equity market may no longer prove as supportive for banks’ earnings prospects.
A shift in banks’ risk appetite is a possibility, given the squeeze on margins and availability of cheap funding. Japanese “mega banks” have undoubtedly lowered their exposure to interest-rate risk by off-loading their holdings of JGBs. This was highlighted by a further 6%-7% reduction in JGB holdings in the three months to December 2013, following a massive reduction earlier in the year. But it remains unclear if the banks will continue such off-loading at the same pace - as bond valuations price in firmer inflation expectations, and as the central bank nears the end of its monetary base expansion (to raise inflation) by year-end.
Risk profiles could rise depending on the choice of assets. Heightened emerging-market volatility amidst Fed tapering could raise their risk exposure if the banks choose to deploy their ample liquidity in emerging-market loans or acquisitions. Moreover, concentration risks could also rise if the banks opt to supplement recent increases in short-term financing for large corporations with long-term debt investments - to assist the expanding overseas footprint of these companies.
For now, Japanese banks are on course to exceed their earnings targets for the financial year ending in March. Bottom-line profitability slowed down somewhat in the quarter ending December 2013. But, on average, the mega banks have already achieved around 90% of their full-year projection. Mizuho has even raised its dividend payout.
Profitability in the last quarter was underpinned by stronger fees and commissions, and reasonable cost control. A pick-up in overseas revenues did materialise due to volume growth and the softening yen - up until December 2013. For the full financial year ending March, bond gains are likely to have fallen substantially - due mainly to the banks’ substantial reduction in JGBs. But the impact on earnings should be cushioned by higher equity gains up to end-2013, and marginal credit costs.