The stable outlook also signifies that it will not be directly influenced by the negative outlook on the sovereign rating on Japan (AA-/Negative/A-1+), based on Bank of Yokohama's current stand-alone credit profile (SACP) and our current assessment that its likelihood of receiving extraordinary government support is "moderately high."
We may revise upward Bank of Yokohama's SACP and raise the issuer credit rating (ICR) on the bank if its core profitability, which acts as a buffer against higher credit costs, improves beyond our assumptions and strengthens its financial base. Conversely, the ratings may come under downward pressure if risks assumed by the bank increase significantly relative to its capital and profitability due to rapid deterioration in its asset quality. For instance, we could consider a downgrade if we see a high likelihood of the bank's RAC ratio falling below 10%.
Standard and Poor's bases its ratings on Bank of Yokohama on the bank's "adequate" business position, "strong" capital and earnings, "adequate" risk position, "average" funding, and "strong" liquidity. The bank's 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 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.
We assess Bank of Yokohama's business position as "adequate." The bank's total assets stood at JPY12.6 trillion as of the end of March 2012, the highest among Japan's 64 regional banks on a stand-alone basis. The gross prefectural domestic product of the bank's home market of Kanagawa Prefecture is almost equal to the GDP of Greece or Denmark, ranking it fourth among Japan's 47 prefectures. The bank has maintained a strong customer base and a stable revenue base in Kanagawa Prefecture over the years. It holds high shares in the prefecture's loan and deposit markets at 32% and 23%, respectively, as of March 31, 2012, surpassing the second-largest bank in the prefecture. From a nationwide perspective that includes major banks, however, Bank of Yokohama's customer base is limited and its operating base is concentrated in particular regions. Meanwhile, the bank has maintained a prudent and conservative management policy, focusing on retail lending to small and midsize enterprises (SMEs) and the residential mortgage loan business.
Our assessment of Bank of Yokohama's capital and earnings is "strong." In our view, the bank's profitability appears slightly low by international comparison, although its capitalization is strong. We expect the RAC ratio to remain in the 10.0%-10.5% range over the next 18 months or so, which is high according to international standards. However, its core net operating profit, which indicates fundamental earnings capacity, may slightly decline, given limited demand for bank lending as well as shrinking profit margins due to fierce competition. The SME 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, Bank of Yokohama's 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. Under our base-case scenario, we believe that incremental credit costs will be limited. Nevertheless, the bank's asset quality could deteriorate further if growing uncertainties in the global economy significantly slows domestic growth and drags down the earnings of the bank's corporate customers. 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 assessment of the bank's risk position is "adequate." We do not expect to see a material change in the bank's risk position and the risk assets in its loan portfolio over the next year or two. Its NPL ratio, after eliminating loan loss reserves, remained at slightly low levels among the rated regional banks, standing at 1.5% as of the end of March 2012. In the past five years, its credit cost ratio exceeded Standard & Poor's normalized loss levels on several occasions, including the period of economic turmoil following the collapse of Lehman Brothers Holdings Inc. in fiscal 2008 (ended March 31, 2009). 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. On the other hand, the interest rate risk volume assumed by the bank relative to its Tier 1 capital and core net operating profit is greater than that of its international peers, although it is restrained compared with other rated regional banks. In our view, its interest rate risk volume has been increasing because the bank's investments in bonds have grown in recent years, backed by its growing deposits.
We assess Bank of Yokohama'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, Bank of Yokohama secures a high level of deposits. As such, we are not particularly concerned about the bank's liquidity. It is not directly affected by changes in the funding market environment because its deposits cover all its lendable funds (its loan-to-deposit ratio stood at 81% as of March 31, 2012). In addition, it has issued a limited amount of corporate bonds worth JPY64.3 billion, which is equivalent to 0.6% of its total deposits. It invests excess funds in assets with relatively high liquidity, such as Japanese government and municipal bonds. It has a stable deposit base that generally consists of small-lot deposits mainly from individual accounts, which make up about 80% of its total deposit balance.
Standard and Poor's assesses the likelihood of extraordinary government support for Bank of Yokohama 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 Bank of Yokohama'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 Bank of Yokohama is 'A', which is on par with the bank's SACP, even after factoring government support into the rating. This is because Bank of Yokohama'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