(The following statement was released by the rating agency)
Nov 13 -
Summary analysis -- Hyakugo Bank Ltd. ----------------------------- 13-Nov-2012
CREDIT RATING: A/Negative/A-1 Country: Japan
Primary SIC: Commercial banks,
Credit Rating History:
Local currency Foreign currency
08-Dec-2011 A/A-1 A/A-1
13-Mar-2002 A-/A-2 A-/A-2
The negative outlook reflects our view that the issuer credit rating (ICR) on Hyakugo Bank Ltd. (A/Negative/A-1), which incorporates one notch of government support, may be lowered if we lower the sovereign rating on Japan (AA-/Negative/A-1+).
Standard & Poor's Ratings Services may consider negative rating actions if the sovereign rating on Japan is lowered, or if it sees a high likelihood for the bank's risks to materially increase against its capitalization and profitability, causing its asset quality to deteriorate. In our view, a downgrade trigger for Hyakugo Bank would be a decline to below 7% in our risk-adjusted capital (RAC) ratio for the bank coupled with our view that it will likely remain at that level for a long time. We may also consider lowering the ratings on Hyakugo Bank if we believe that it is incapable of preventing further declines in its profitability. Conversely, we may revise upward its stand-alone credit profile (SACP) and the rating outlook if the bank's core profitability, which would act as a buffer against increased credit costs, improves beyond our assumptions and strengthens its financial base.
In our base-case scenario for Hyakugo Bank, we have incorporated the risk of an increase of about one percentage point in the bank's nonperforming loan (NPL) ratio, in light of the scheduled expiration of the Small and Midsize Enterprises (SME) Finance Facilitation Act. We also expect the bank's profitability to remain at a slightly low level.
Standard & Poor's ratings on Hyakugo Bank reflect its "adequate" business position, "adequate" capital and earnings, "adequate" risk position, "average" funding, "strong" liquidity, as well as a "moderately high" likelihood to receive extraordinary government support, if necessary. The SACP on Hyakugo Bank 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 ICR. Our anchor SACP for a bank operating only in Japan is 'a-'. The BICRA score is first informed by our evaluation of economic risk. We view Japan as a developed and diverse economy with 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 Hyakugo Bank's business position as "adequate." The bank maintains a strong customer base in Mie Prefecture. In comparison with Japan's 64 regional banks, Hyakugo Bank is a midsize regional bank in terms of assets, holding approximately JPY4.5 trillion in total consolidated assets as of March 31, 2012. Nevertheless, it is the largest among banks based in Mie Prefecture, whose prefectural economy is almost comparable to Vietnam's GDP. It has long maintained stable earnings, underpinned by its local market share (33% of deposits and 27% of loans at the end of March 2011), which places it far ahead of its competitors. On a nationwide basis, however, its customer base is limited, and its operations are concentrated in a specific geographical area. Hyakugo Bank continues to focus on retail lending--loans to small and midsize enterprises (SMEs) and housing loans--and maintains a prudent business policy.
Hyakugo Bank's capital and earnings are "adequate," in our view. We expect the RAC ratio--which we consider to be the main indicator of a company's financial standing and value in our credit quality analysis--to move within a range between about 9.5% and 10.0% over the next 18 months or so, which is adequate by global comparison. However, we believe the bank's core net operating profit, which is an indicator of basic profitability, may inch down because its loan interest margin has been shrinking amid limited loan demand and intensifying competition. In addition, the SME Finance Facilitation Act, which has been supporting the SMEs' credit quality, is set to expire in March 2013. Given that SME loans generally account for a high percentage of regional banks' total lending, their NPL ratio may rise on the expiration of the legislation. The regional banks could subsequently see an increase in credit costs over the next 18 months or so. Standard & Poor's base-case scenario for Hyakugo Bank incorporates the risk of an increase of about one percentage point in the bank's NPL ratio as a result of the expiration of the Act. Under this scenario and in light of the bank's coverage ratio and other factors, we expect an increase in the bank's credit costs to be limited. Nevertheless, if domestic economic growth substantially slows due to increased uncertainty in the global economy, Hyakugo Bank's asset quality may worsen beyond our assumptions if the earnings of its corporate borrowers deteriorate. SMEs are regional banks' main customers and they are particularly susceptible to business cycles, compared with large corporations. As such, the impact of economic changes on Hyakugo Bank's asset quality remains a key factor in our analysis of its credit quality.
Standard & Poor's assesses the bank's risk position as "adequate." We expect Hyakugo Bank to maintain an adequate risk management system based on our assumption that the bank's risk position or volume of risk assets, such as loans, will not change materially for the next one to two years. As of March 31, 2012, the bank's net NPL ratio stood at 2.4%, up 0.5 percentage point from the average among rated regional banks. In the past five years, Hyakugo Bank's annual ratio of credit costs exceeded our normalized loss ratio, which was calculated when Lehman Brothers Holdings Inc. collapsed in fiscal 2008 (ended March 31, 2009). However, Hyakugo Bank's financial results, including losses, have been generally stable compared with those of major banks because its loan portfolio mainly consists of SME loans and housing loans, which are diversified into small lots. In addition, its investment banking and trading businesses are limited, and thus, the degree of operational complexity is low. Compared with its international peers, however, Hyakugo Bank assumes a greater volume of interest rate risk relative to its Tier 1 capital and core net operating profit. This is because, in recent years, its growing deposits have fueled a material increase in bond investments. Therefore, Standard & Poor's believes the bank's financial standing is susceptible to interest rate fluctuations.
Hyakugo Bank's funding is "average" and its liquidity is "strong," in our view. The main funding source is its stable core deposit base, which is diversified into small lots. The bank has secured a high level of deposits, thanks to a strong customer base. As such, its liquidity risk is low, in our opinion. The bank is immune to changes in the funding market conditions because it covers all lendable funds with its deposits; its loan-to-deposit ratio stood at 62% as of March 31, 2012. Funds that were raised through corporate bond issuance and borrowing amount to JPY61.7 billion, which is small compared with its outstanding deposits of JPY4 trillion. Excess funds are mainly invested in assets with relatively high liquidity, including government and municipal bonds. Individual deposits, which are generally more diversified than corporate deposits, account for 73% of the bank's total deposits (yen-denominated liquid deposits), making Hyakugo Bank's deposit base highly stable.
The long-term counterparty credit rating on Hyakugo Bank is one notch higher than the SACP, reflecting our view that the bank is likely to receive extraordinary government support if necessary. Standard & Poor's determines the likelihood of government support based on the bank's systemic importance within the country where it is located, and the government's tendency to support banks. We assess Hyakugo Bank as one with "moderate" systemic importance in Japan, and we consider the tendency of government as "highly supportive." As a result, we view the likelihood of government support to Hyakugo Bank as "moderately high," which is the second-highest assessment on a four-degree scale.
Related Criteria And Research
Banks: Rating Methodology And Assumptions, Nov. 9, 2011
Banking Industry Country Risk Assessment Methodology And Assumptions, Nov. 9, 2011