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Industry Report Card: Japan Major Bank Credit Costs To Subside Slowly

Japan's five major banking groups could be in for a long wait before a doubling of credit costs in the past year recedes to pre-pandemic levels.

S&P Global Ratings forecasts that the groups' aggregate credit costs will decrease to about ¥650 billion in fiscal 2022 (ending March 31, 2023), based on its macroeconomic scenario. Each group's earnings will grow 5%-10% annually under our base-case scenario, with asset quality and capital levels remaining stable.

Two risk factors might stymie a recovery. First, credit costs could be higher than our expected scenario if household and corporate borrowers riding a wave of support from the government's pandemic-related economic stimulus do not recover their ability to repay debt. Second, the groups face downside risks from irregular conditions in global capital markets. These may lead to higher foreign currency funding costs and lower earnings in capital markets divisions.

Efforts to reduce strategic shareholdings will help stabilize capital ratios, in our view. Each of the five banking groups has progressed plans to slash strategic shareholdings. We think reduced stockholdings will help stabilize the groups' capital ratios. At the same time, each needs to enhance its earnings capacity, in our view.

Japan's five major banking groups are Mitsubishi UFJ Financial Group Inc. (MUFG), Mizuho Financial Group Inc. (Mizuho group), Sumitomo Mitsui Financial Group Inc. (SMFG), Resona Holdings Inc., and Sumitomo Mitsui Trust Holdings Inc. (SMTH). We rate Resona Bank Ltd. and Sumitomo Mitsui Trust Bank Ltd.

Table 1

Summary Of Aggregate Financial Results For Japan's Five Major Banking Groups
Fiscal year 2020 (Bil. ¥) Year-on-year growth (%)
Net interest income 4,789 7.4
Net fees and commissions 3,560 1.5
Expenses 6,805 0.5
Credit costs 1,146 81.3
Net operating profits 3,649 2.8
Pretax profits 2,750 (1.4)
Net income 2,027 1.6
Loans 345,495 1.2
Japanese government bonds 72,337 61.6
Total assets 978,127 8.5
Deposits 639,402 10.0
Regulatory risk-weighted assets 285,504 3.7

A Scenario For Recovery

The five groups' heightened credit costs are likely to abate in fiscal 2022, in our base-case scenario. We expect their aggregate credit costs to decline to about ¥650 billion in fiscal 2022 from over ¥1.1 trillion in fiscal 2020. Our expectation of their credit costs for fiscal 2022 would be on par with the ¥632 billion result in fiscal 2019, which included forward-looking loan loss provisions. Our macroeconomic scenario is for a quicker recovery from the current pandemic than from the global financial crisis of 2008-2009. Thus, we expect accumulated credit costs for the three years from the start of the pandemic to be about 60% of the total for the three years from the start of the financial crisis. We forecast Japan's real GDP growth will be 2.7% in 2021 and 2.0% in 2022, respectively (on a calendar year basis; forecasts of GDP growth in chart 1 are on a fiscal year annualized basis).

Chart 1


The five major banking groups will grow their profits 5%-10% annually in the next two years, under our base-case scenario. This will be thanks mainly to a rebound in economic activity and lower credit costs. Fiscal 2020 profits were almost in line with those of the previous fiscal year despite higher credit costs. Major factors behind solid performance include growing demand for lending from corporations moving to secure liquidity and increased fee income amid buoyant activities in capital markets. We expect earnings momentum to continue in fiscal 2021.

Table 2

Japan's Five Major Banking Groups' Guidance On Profits And Credit Costs
Mitsubishi UFJ Financial Group Inc. Mizuho Financial Group Inc. Sumitomo Mitsui Financial Group Inc. Resona Holdings Inc. Sumitomo Mitsui Trust Holdings Inc.
(Mil. ¥) March 2021 (actual) March 2022 (guidance) March 2021 (actual) March 2022 (guidance) March 2021 (actual) March 2022 (guidance) March 2021 (actual) March 2022 (guidance) March 2021 (actual) March 2022 (guidance)
Net operating profit* 1,248,423 1,100,000 797,731 790,000 1,084,015 1,120,000 192,092 202,000 294,707 280,000
Credit costs 515,530 350,000 204,974 100,000 360,520 300,000 57,435 44,000 7,808 20,000
Credit cost ratio (bp)§ 48 33 25 12 43 35 15 11 3 7
Net income 777,018 850,000 471,020 510,000 512,812 600,000 124,481 145,000 142,196 155,000
*Resona Holdings' net operating profits are aggregate figures of its bank subsidiaries. §The denominator of the credit cost ratio for March 2021 is an average of loan outstanding amounts for fiscals 2019 and 2020. The denominator for March 2022 is the loan outstanding amount for fiscal 2020. bp--basis points. Source: Each company's financial presentation for fiscal 2020.

We expect each group to manage asset quality and maintain an appropriate level of regulatory capital. Asset quality of the five banking groups deteriorated slightly in fiscal 2020, as measured by their combined gross nonperforming loan (NPL) ratio, amid the COVID-19 pandemic (see chart 2). However, pandemic-related government financial assistance for corporations and relief payments to individuals limited the slide. We expect downward pressure on asset quality to remain, particularly for assets in industries that the pandemic has severely affected. However, potential harm to profits from future erosion of asset quality is likely to remain manageable. This is because the five major banking groups have made forward-looking loan loss provisions to cope with the COVID-19 pandemic.

Common equity tier 1 (CET1) ratios for the five groups as of the end of fiscal 2020 were almost in line with, or moderately improved from, the previous year. Rises in unrealized gains on stockholdings thanks to higher domestic stock prices and accumulation of profits have boosted each group's regulatory capital. Increased regulatory capital wiped out the impact of higher regulatory risk-weighted assets (RWA) stemming from declines in asset quality and growth in lending. In addition, each group has allocated much of the rise in its deposit balance to investments in Japanese government bonds (JGBs) and deposits at the Bank of Japan. This also has moderated the increase in regulatory RWA of each group, in our view.

Chart 2


Table 3

Regulatory Capital, Leverage, And Total Loss-Absorbing Capacity Ratios For Japan's Five Major Banking Groups
Mitsubishi UFJ Financial Group Inc. Mizuho Financial Group Inc. Sumitomo Mitsui Financial Group Inc. Resona Holdings Inc. Sumitomo Mitsui Trust Holdings Inc.
% March 2020 March 2021 March 2020 March 2021 March 2020 March 2021 March 2020 March 2021 March 2020 March 2021
CET1 ratio 11.9 12.3 11.7 11.6 15.6 16.0 12.3 13.3 12.6 12.1
CET1 ratio excluding unrealized securities gains after full implementation of Basel III 9.6 9.7 8.8 9.1 9.8 9.8 9.1 9.0 N.A. N.A.
Leverage ratio 4.4 5.5 4.1 4.8 4.3 5.7 N.A. N.A. 4.6 5.5
TLAC ratio (as a percentage of RWA) 18.6 18.9 22.0 21.4 26.0 25.8 N.A. N.A. N.A. N.A.
Note: Ratios for March 2021 include preliminary figures. Ratios for Resona Holdings Inc. are reference data disclosed by the company. CET1--Common equity tier 1. TLAC--Total loss-absorbing capacity. RWA--Risk-weighted assets. N.A.--Not applicable. Source: S&P Global Ratings, based on company disclosures.

Main Risk Factors On The Path To Economic Recovery

The first risk factor is potentially weaker creditworthiness of corporate and individual borrowers currently buoyed by the Japanese government's economic stimulus package. Most financial support in response to the COVID-19 shock is temporary. Accordingly, the groups' credit costs could increase if borrowers' capacity to repay debt does not recover by the time such measures end or subsidies on interest diminish three years after implementation of loans advanced under the stimulus package (see "Japan Banking Outlook 2021: Expect Rising Credit Risks," published Jan. 14, 2021). Meanwhile, the banking groups shifted in the second half of fiscal 2020 from supporting corporate customers' financial needs in the early stage of the COVID-19 crisis to addressing longer-term capital needs. We think capital financing amid accelerated secular shifts to do with energy transition and digitalization will require each banking group to demonstrate stronger abilities to assess targeted businesses and industries.

The second risk factor is irregular conditions in global capital markets in the recovery from the pandemic. Rising volatility or repricing in markets could potentially hurt the five groups' foreign currency funding environment or securities portfolios. We assess the groups as having high stability in funding and liquidity compared with international peers. Therefore, any deterioration in the foreign currency funding environment during the recovery process could pressure creditworthiness. In fiscal 2020, when the pandemic started spreading globally, foreign currency funding conditions remained stable as major central banks collaborated globally to provide dollar funding. Foreign currency lending of the four groups apart from Resona Holdings declined about 9% from the previous year (see chart 3). This was mainly because corporate borrowers' needs for dollar funding were mostly satisfied and their funding activities had shifted to capital markets amid favorable conditions.

The groups' securities subsidiaries produced largely strong financial results in fiscal 2020 (see "Japan Brokerages Enjoyed Tailwinds, Now Structural Reform Is Key," published May 27, 2021). However, the subsidiaries' revenues and profits in overseas businesses are highly volatile, and they could risk making substantial trading losses relative to business scale in the event of market dislocations.

Chart 3


Cutting Strategic Shareholdings; Stabilizing Capital Ratios

We think the five groups' efforts to reduce strategic shareholdings will likely help improve their capital ratios and make them more predictable. Each group has pushed ahead with plans to slash strategic shareholdings. Among others, SMTH recently announced its intention to cut its cross-shareholdings to zero with an acceleration of such efforts. We apply very high risk-weights to equity investments under our risk-adjusted capital (RAC) framework. This is one reason Japan's major banking groups have lower RAC ratios than major non-Japanese global systemically important banks (G-SIBs; see note 1) (see chart 4). Strategic shareholdings also can erode stability of each group's capitalization because movements in stock prices have the potential to alter capital ratios.

Chart 4


A key challenge we see for the five groups is to develop stable revenue bases without relying on stockholdings. Major U.S. banking groups lost profitability temporarily in fiscal 2019, due mainly to the COVID-19 pandemic and in part to changes in provisioning standards. However, U.S. peers still remain far more profitable than Japan's major banking groups (see chart 5). In addition, dividends and capital gains on sales of strategic shareholdings have supported net profit at Japan's major banking groups (see chart 6). Prior to the COVID-19 pandemic, each group had expanded overseas operations, which are more profitable than domestic operations. However, a persistent low interest rate environment globally would push down profitability at overseas businesses. We will monitor any developments in business sectors or regions that each group targets for earnings opportunities. This is because the direction each group takes for future growth could affect its creditworthiness, in our opinion.

Chart 5


Chart 6


Major banks view ongoing efforts to reduce greenhouse gas emissions as a business opportunity. Japan's government aims to achieve carbon neutrality by 2050, and each of the five groups is accelerating efforts to reduce such emissions. Many financial institutions and investors are likely to support companies working to reduce emissions, mainly in carbon-intensive industries. Through engagement with corporate customers, major banking groups set target financing amounts to reduce carbon emissions. The groups are also moving to raise those target amounts.

Table 4

Japanese Major Banks' Recent Announcements On Efforts To Cope With Climate Change
Date Summary

Mitsubishi UFJ Financial Group Inc.

April 2021 April 1: Revised upward its cumulative target in sustainable finance through fiscal 2030 to ¥35 trillion from ¥20 trillion previously. April 26: Will stop financing upgrades of existing coal-fired power plants, in addition to already halting financing of new coal-fired plants in principle.
May 17, 2021 Will aim for net zero greenhouse gas emissions in its finance portfolio by 2050 and in its own operations by 2030.

Mizuho Financial Group Inc.

May 13, 2021 Goal of cutting outstanding loans to coal-fired power plant projects to zero by fiscal 2040. Aims to achieve net zero greenhouse gas emissions in Japan and at overseas operational sites by 2050.

Sumitomo Mitsui Financial Group Inc.

May 12, 2021 Will obtain a clear understanding of greenhouse gas emissions that its loan/investment portfolio generates (Scope 3 of Greenhouse Gas Protocol) and set targets to reduce those emissions. Also indicated it will revise upward to ¥30 trillion from ¥10 trillion previously its target of executing green finance between fiscals 2020 to 2029. This also includes social finance, which helps resolve social issues such as poverty and the environment. It will also halt financing of new coal-fired power plants.
Source: S&P Global Ratings, based on companies' disclosures.


1. This report uses data on Citigroup, Bank of America, JPMorgan Chase, Barclays, HSBC, BNP Paribas, and Deutsche Bank, which we refer to collectively as the major foreign G-SIBs.

G-SIBs (global systematically important banks) refer to banks designated by the Financial Stability Board and include Japan's three megabank groups.

Issuer Review

Table 5

Issuer Review
Company Issuer credit rating Senior unsecured debt rating Comments Analyst

Mitsubishi UFJ Financial Group Inc.

A-/Stable/-- A- An expected fall in MUFG's credit costs and normalization of its business are positive factors for the group. However, issues remain, including the need to both replace less profitable assets in its portfolio amid a low interest rate environment globally and to improve profitability of its domestic banking business. The group's credit costs rose in fiscal 2020 as it adopted more conservative provisioning standards, primarily at the group's U.S. subsidiaries, on top of the effects of the COVID-19 pandemic. While this dampened the group's net profit, profit growth in its global markets business unit and U.S.-based Morgan Stanley, an equity-method affiliate of MUFG, mitigated the damage. Under its three-year midterm management plan from fiscal 2021, MUFG aims to increase and stabilize net profit while maintaining its outstanding balance of RWA. Hurdles to securing stable profit are high, but efforts to diversify revenue sources are likely to underpin the group's profits, in our view. Kensuke Sugihara

MUFG Bank Ltd.

A/Stable/A-1 A See comments above. Kensuke Sugihara

Mitsubishi UFJ Trust and Banking Corp.

A/Stable/A-1 -- See comments above. Kensuke Sugihara

Mizuho Financial Group Inc.

A-/Stable/-- A- Downward pressure on our capital assessment of Mizuho group is likely to continue, given its financial results for fiscal 2020. The group has a policy of strengthening shareholder returns while cautiously monitoring the effects of the pandemic. Its regulatory capital ratio as of the end of March 2021 had declined marginally but remained almost flat from a year earlier. Its lending balance has been decreasing, particularly in overseas operations, after peaking in September 2020. Mizuho group's consolidated net operating profit, including gains or losses related to exchange-traded funds, jumped 16% year on year--reflecting solid performance of customer-related business and market operations. Credit costs for fiscal 2020 include ¥72.3 billion in forward-looking loan loss provisions. Toshihiro Matsuo

Mizuho Bank Ltd.

A/Stable/A-1 A See comments above. Toshihiro Matsuo

Mizuho Trust & Banking Co. Ltd.

A/Stable/A-1 -- See comments above. Toshihiro Matsuo

Sumitomo Mitsui Financial Group Inc.

A-/Stable/-- A- SMFG aims to lift its consolidated net operating profit ¥100 billion under its midterm management plan. This is despite expected persistent downward pressure on operating revenues from some of its businesses in the recovery from COVID-19. Whether the group can expand its earnings without harming the balance between risks and capital is key to our credit analysis of the group. The group's consolidated net operating profit for fiscal 2020 was almost flat year on year. This is because buoyant performances in retail asset management, overseas securities operations, and market business offset a pandemic-induced decline in earnings. The group has already factored into its earnings forecast for fiscal 2021 a ¥170 billion impact from COVID-19, such as lower profits in consumer finance and aircraft leasing business as well as continued high credit costs. At the same time, it is pursuing profit growth from its retail and overseas businesses. Chizuru Tateno

Sumitomo Mitsui Banking Corp.

A/Stable/A-1 A See comments above. Chizuru Tateno
Resona Holdings Inc. Not rated Key to our credit assessment for Resona Holdings is the group's ability to continue to increase fee income and reduce operating expenses to offset declining net interest income from lending. The group's net operating profit before loan loss provisions fell year on year in fiscal 2020. However, solid performances in corporate solutions, settlement-related services, and fund wrap contracts increased fee income for the year. The group has also made progress in reducing operating costs. Credit costs, including forward-looking loan loss provisions, rose substantially year on year but were lower than we had assumed. The group announced a share buyback plan associated with the full takeover of Kansai Mirai Financial Group Inc. We think the group's capital ratio as we define it will likely remain appropriate, given an improved regulatory capital ratio and earnings forecasts that include incorporation of net income thus far distributed to minority shareholders. Satoru Matsumoto

Resona Bank Ltd.

A/Stable/A-1 -- See comments above. Satoru Matsumoto
Sumitomo Mitsui Trust Holdings Inc. Not rated SMTH has indicated its policy of selling all strategic shareholdings and not holding them in principle. We view this move as credit positive for the group because it is likely to stabilize its capital relative to risks it takes. The group aims to cut about ¥250 billion in strategic shareholdings (on a market value basis), or about 18% of total shareholdings, by the end of March 2023. Under our RAC framework, the group's market risk, including that from strategic shareholdings, accounts for about 25% of total RWA. In fiscal 2020, the pandemic cut net fee income 3.6% year on year. However, net operating profit before loan loss provisions increased from a year earlier because a rise in net interest income and a fall in expenses more than offset the decline in net fee income. The group's net interest income included one-off profits from limited partnerships (about ¥6 billion) and the effects of a temporary rise in demand for lending (about ¥3 billion). The year-on-year fall in net profit is primarily attributable to position adjustments, including hedging against a potential decline in market value of strategic shareholdings. Toshihiro Matsuo

Sumitomo Mitsui Trust Bank Ltd.

A/Stable/A-1 A See comments above. Toshihiro Matsuo

Related Research

This report does not constitute a rating action.

Primary Credit Analyst:Toshihiro Matsuo, Tokyo + 81 3 4550 8225;
Secondary Contacts:Chizuru Tateno, Tokyo + 81 3 4550 8578;
Kensuke Sugihara, Tokyo + 81 3 4550 8475;
Satoru Matsumoto, Tokyo + 81 3 4550 8673;

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