ANALYSIS-Lending, not subprime, real worry for Japan banks

TOKYO, Dec 3 (Reuters) - The U.S. subprime credit crisis has slashed Japanese banks’ earnings and pushed their already lacklustre share prices even lower, but lenders aren’t likely to see relief without an improvement in loan demand.

On top of subprime-related losses, large banks such as Mitsubishi UFJ Financial Group Inc 8306.T, and Sumitomo Mitsui Financial Group Inc 8316.T are bruised by slower lending, weak fee income and ties to the troubled consumer finance sector.

The banks have also been unable to pass on interest rate hikes to customers due to cut-throat competition, putting pressure on interest margins.

“It’s hopeless,” said Kristine Li, bank analyst at KBC Securities, when asked about the outlook for Japan’s lenders.

“Their main banking businesses are not growing ... Before we hoped they could grow their earnings after the (Bank of Japan) brought interest rates to a normalised level.”

Investors seem to agree, sending Tokyo's bank index .IBNKS.T to a three-year low last month, although it has since recouped some losses. For the year, banks are down about 21 percent, against a 9 percent drop in the TOPIX index .TOPX.

Analysts said growth of the banks’ net interest income, a measure of earnings from lending, has been razor thin.

Among Japan’s top three banks, leader MUFG booked the biggest improvement for the six months to September, with a 2.2 percent year-on-year rise.

Sumitomo Mitsui, Japan's third-largest bank, was just slightly behind that, while Mizuho Financial Group Inc 8411.T reported a dismal 0.5 percent increase.

In comparison, Europe's HSBC Holdings Plc HSBA.L booked an almost 9 percent rise for the six months to June. DOOM AND GLOOM

Mortgage lending, one of the few bright spots for Japan’s banks, is expected to drop sharply following a plunge in housing starts due to stricter building codes adopted in June.

“In terms of mortgages, the change in the construction law will take about six months to have an impact,” said Masaki Iso, chief investment officer at Yasuda Asset Management.

“Banks are going to start feeling the pinch from here.”

Japan’s housing starts fell 35 percent in October from a year earlier, marking their fourth straight monthly decline and following a record 44 percent drop in September.

To be sure, Japanese banks have not escaped unscathed from the U.S. subprime mortgage market crisis and ensuing global credit squeeze.

Japan’s Financial Services Agency said large banks had about $11 billion invested in subprime-related products and suffered about $910 million in losses as of the end of September.

But that is just a small portion of the more than $50 billion in losses and write-downs announced by global banks. In one of the most high-profile cases, Citigroup Inc C.N has estimated write-downs as high as $11 billion.

Analysts therefore reckon ties to consumer lenders may be a bigger worry.

MUFG lost 4 billion yen ($35 million) on subprime investments in the first half, a sliver of the 60 billion yen hit it took on losses at its credit card affiliate Mitsubishi UFJ Nicos Co Ltd 8583.T.

“The (consumer loan) industry seems to be teetering on a knife edge and clearly it has the potential to get worse in the second half,” said David Threadgold, bank analyst at Fox-Pitt, Kelton.

Stricter regulation has forced consumer lenders to lower the maximum interest rates they can charge, pushing many firms deep into the red.


Part of the problem may be that Japan’s big banks -- famous for their staid business style and arcane bureaucracies -- have relied too long on plain vanilla lending.

Compared with their overseas competitors, Tokyo banks haven’t been aggressive in securities, syndicated loans for mergers and acquisitions or new services and products, said Soichiro Monji, chief strategist at Daiwa SB Investments.

“If Japanese banks had such offerings, they could still be attractive despite the fact that their lending businesses aren’t growing,” Monji said.

While income from interest still accounts for over half of Mitsubishi UFJ’s gross profits, at HSBC it makes up about 40 precent of total operating income.

One example could be be mid-sized lender Tokyo Star Bank 8384.T.

Although a niche player in Japanese banking, it has benefited from offering products not available from traditional Japanese lenders, such as deposit-linked mortgages -- where the cost of the mortgage is lowered as customers increase deposits.

The bank more than doubled its earnings in the first half, even as larger rivals saw double-digit declines.

Whatever course Japan’s large banks take, Daiwa SB’s Monji said one thing is certain: they need to change.

“They can no longer rely only on the traditional model of taking deposits, loaning out money and profiting from the spread.”

($1=110.22 Yen)

(Editing by Jean Yoon)

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