Smaller regional banks in Japan are under renewed pressure to consolidate, as the looming expiry of government guarantees on cheap loans to pandemic-hit borrowers adds to their troubles in an already challenging environment.
Most Japanese lenders, including regional banks, face potentially higher delinquency rates on trillions of yen of loans extended to businesses between May 2020 and March 2021 during the COVID-19 pandemic. Total loans under the Japanese government's three-year, no-interest lending program amounted to about ￥23 trillion as of Feb. 17, 2022, according to the country's Small and Medium Enterprise Agency. Borrowers were still required to pay principal.
As the interest holiday ends, many of the more than 60 regional lenders are likely to take a hit and that would push them to consider mergers to survive, analysts said.
"I'm pessimistic about the outlook for regional banks," said Katsuhide Takahashi, CEO of financial consulting firm Malibu Japan. "Consolidation could be a basic scenario to explore as a banks could not survive alone."
Push for consolidation
Japan's banks have been facing profit pressures for years amid ultralow interest rates and a declining population. While bigger lenders have more resources, the country's government has encouraged regional banks, particularly smaller ones in the same prefecture, to integrate to prevent them from going under, as well as to strengthen assets and cut costs.
Authorities have offered incentives for regional bank consolidation, such as additional interest on lenders' deposits with the central bank if they meet certain benchmarks on costs and integration. The Financial Services Agency in 2018 identified 23 prefectures where not even a single lender could operate profitably. It also identified that 12 regions could sustain just one bank each, while 10 could accommodate up to two banks.
Banks with assets of less than ¥1 trillion or core operating profit of less than ¥1 billion would be potential merger candidates, Takahashi said.
Regional bank struggles
Bankruptcies in Japan rose for nine consecutive months, hitting a monthly high of 606 in December 2022, according to Tokyo Shoko Research. The research firm attributed the business failures to the end of the government-subsidized loans.
"Increasing bankruptcies led to growing bad loans at smaller regional banks," said Yoshihiro Sakata, a manager of Tokyo Shoko Research's information department.
At the same time, regional banks are losing money on lower returns on their holdings of foreign securities, mainly U.S. Treasuries, as rising U.S. interest rates drive up the cost of borrowing funds for lending and investments, analysts said.
Concordia Financial Group Ltd., one of the major regional banks, reported a valuation loss of ¥31.6 billion on foreign debt securities in the fiscal first half ended Sept. 30, 2022, driving net unrealized losses on available-for-sale securities to ¥42.4 billion, according to the group's earnings statement for the period.
Japanese regional banks actively invest in foreign securities, including bonds, and a rise in U.S. interest rates since early 2022 exposed them to billions of yen of valuation losses, putting pressure on their already weak metrics. The aggregate nonperforming loans of regional banks stood at ¥4.325 trillion as of Sept. 30, 2022, with steady year-over-year increases from ¥3.446 trillion at Sept. 30, 2017, according to data from the Regional Banks Association of Japan.
As of Sept. 30, 2022, Japanese regional banks' average balance of holdings of foreign securities accounted for 17.7% of their overall securities assets, according to the data. Their aggregate investment in foreign securities totaled ¥12.7 trillion, compared to ¥14.8 trillion of investments in domestic government bonds.
Higher funding costs, driven by the higher U.S. rates, are another problem that regional banks need to contend with. Such costs, including raising U.S. dollar funds, at the banks surged to ¥136.5 billion in the fiscal first half from ¥51.2 billion in the prior-year period, according to the regional banks association.
"Some of [the regional banks] have no choice except to consider a merger to stay alive," said Shunsuke Oshida, head of credit research at Manulife Investment Research Japan.
Potential deals
The Bank of Yokohama Ltd.'s recently announced move to take over The Kanagawa Bank Ltd. raises the prospect that other deals among Japanese regional banks may follow suit in 2023 as the lenders need to shake up operations amid inflationary pressure, analysts said.
The deal, if completed, would be the latest in a series of Japanese regional bank consolidations in the recent years.
As of Sept. 30, 2022, Bank of Yokohama's assets stood at ¥21.6 trillion, compared to Kanagawa Bank's assets of ¥558.5 billion. The bidder's core operating profit of ¥47.3 billion for the period was also far above the target's ¥1.1 billion.
"We're cementing a foothold in our area," a Bank of Yokohama spokesman said, declining to elaborate further. A Kanagawa Bank spokesman declined to comment.
Bank of Yokohama aims to expand business in Greater Tokyo, to "avoid losing ground over to megabanks," said Takahide Kiuchi, executive economist at Nomura Research Institute and a former member of the Bank of Japan's monetary policy committee.
As of March 7, US$1 was equivalent to ¥136.91.
