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Japan Brokerages' Resilience Hinges On Managing Market Changes

Japan's securities groups face some tough going.

They are likely to see their retail earnings bases strengthen only slowly amid weak customer flows and sagging investment banking revenue in fiscal 2023.

S&P Global Ratings believes the credit quality of major Japanese securities groups we rate will hinge on their ability to increase retail revenue and manage risk to prevent a plunge in revenue from capital markets businesses.

If market uncertainty persists, we think customer transactions could stagnate, hindering any increase in earnings of the groups' retail businesses. Demand for financing in equity and bond issuance markets has subsided following a rise during the COVID-19 pandemic. If it continues to shrink due to uncertainty around interest rates and the business climate, revenue from the groups' investment banking businesses will remain sluggish.

In fiscal 2022 (ended March 31, 2023), the five Japan-based securities groups we rate--SMBC Nikko Securities Inc., Daiwa Securities Group Inc., Nomura Holdings Inc., Mizuho Securities Co. Ltd., and Mitsubishi UFJ Securities Holdings Co. Ltd.--suffered a 7% slide in combined revenue and a 53% drop in combined net profit from the previous year. SMBC Nikko made a net loss, partly due to a market manipulation incident. Global interest rate hikes and concern over geopolitical risk stifled customer flow for domestic and foreign equities. Moreover, reduced equity and bond issuance depressed investment banking commissions. Rising market volatility increased customer transactions in the groups' global markets businesses. This helped lift revenue from fixed income products. Nevertheless, the operating environment became increasingly difficult at the end of fiscal 2022. Some groups struggled to manage their overseas fixed income exposures because of unexpected volatility stemming from concerns over financial instability in the U.S. and Europe.

Increased Resilience Will Likely Take Time

Despite their efforts to raise revenues and lower expenditures, securities groups will likely take time to shore up earnings, in our view, given the likely continued uncertain market environment.

The five groups' combined revenue increased 5% in fiscal 2022 from fiscal 2019, before the securities industry benefited from favorable market conditions. However, their combined profit decreased 34%. Even excluding SMBC Nikko, which reported losses in all business segments, the four groups' combined profit fell 15% below pre-pandemic levels. We attribute this to the following:

  • A slow increase in stable revenue from the groups' retail businesses;
  • Higher costs in their wholesale businesses, especially overseas, due to the weak yen and inflation; and
  • A struggle to manage trading positions as market volatility surged unexpectedly, partly offsetting increased revenues from customer flow.

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Caution amid market uncertainty in fiscal 2023 may keep customer flow weak. The groups have sought to build resilient revenue and expenditure structures since before the pandemic. But this has not outweighed falling customer flows due to the unfavorable environment. In their retail businesses, the four groups that disclose stand-alone figures by segment cut combined costs 4% year-on-year in fiscal 2022. Sales of structured bonds to retail customers have been restrained across the industry. The groups have been examining their practices in selling Credit Suisse AG's Additional Tier 1 (AT1) bonds to retail customers. We believe these events could hinder the groups' revenue growth. We take this view because:

  • Sales of related products will likely decrease;
  • Sales staff will likely take time to adjust to alternative products and methods; and
  • Staff may need more time to explain products to customers.

The percentage of revenue from these products varies by group, in our view, but we do not expect a large direct impact on creditworthiness.

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Volatility Brings Earnings Opportunities; Managing Positions Will Be Challenging

Volatility rose significantly in all products related to equity, interest rates, and foreign exchange in fiscal 2022. Especially in fixed income businesses, higher volatility revealed both positive and negative factors. On one hand, earnings grew thanks to increased customer flow. On the other, managing positions has been a challenge.

Fixed income-related revenue, which accounts for a majority of revenue from the groups' global markets business, affects overall performance. In the first half of fiscal 2022, customer flow for interest rate products was strong thanks to increased volatility in interest rates and foreign exchange. In the second half, revenue from domestic interest rate products grew considerably amid rising volatility after the BOJ tweaked yield curve control operations in December 2022. In March 2023, however, volatility rose sharply due to concern over financial instability stemming from the failure of Silicon Valley Bank and concerns about Credit Suisse AG. Along with these events, trading revenue related to overseas interest rates came under pressure due to challenges managing positions in overseas fixed income businesses. Nomura and Daiwa said their fixed income revenue in March 2023 was only about 10% of that of the January-to-March quarter. Earnings from equity businesses were weak throughout the year as investors traded hesitantly.

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Managing risks will be a key challenge if securities groups are to avoid a significant drop in the earnings of their global markets businesses' overseas operations. Their business bases lag those of major players in the U.S. and Europe in both product diversity and scale. This makes it difficult to make up for stagnation of one product with others. For example, Nomura, Daiwa, and Mitsubishi UFJ suffered net losses or material decreases in profits of their Americas businesses in the quarter ended March 31, 2023. This was because of difficulty managing positions in their overseas fixed income businesses. In addition, inflation and the weak yen have driven up costs at the groups' overseas locations regardless of earnings levels. The Americas businesses have made large contributions to the groups' overseas businesses. Market conditions in the U.S. affect not only the groups' global markets revenue but also overall performance through business lines. These include bond underwriting fees in investment banking and U.S. stock-related fees in retail businesses.

Recovery In Primary Markets Requires Greater Certainty

Revenue from the securities groups' investment banking businesses, especially commissions related to equity capital and debt capital markets, is unlikely to reach the levels of the past two years, in our view. This is despite a likely recovery in closing transactions, which may happen if uncertainties ease without a sharp rise in interest rates. We hold this view based on the following:

  • Demand for financing waned after increasing during the pandemic;
  • Some corporations raised long-term funds under easing market conditions following the pandemic; and
  • Some companies have shifted to loans from banks as market interest rates rise.

Revenue from investment banking businesses declined 20% in fiscal 2022 from the previous year at the four securities groups that disclose revenue data by segment. This was because primary deals for stocks and bonds shrank. In the first half in particular, transactions in the primary market were slow due to unstable interest rate movements and uncertainty over the business climate. Advisory revenue from acquisitions and other deals, which the groups have focused on in recent years, will likely continue to make reasonable contributions to earnings, despite the market environment.

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Capital Buffers Are Sufficient Despite Volatility And Basel III Finalization

We expect Nomura and Daiwa to maintain favorable capital levels. Rising volatility and increased exposure to trading assets will increase risk assets at both groups. In addition, Nomura and Daiwa have disclosed estimates indicating regulatory capital ratios will decline by about 3 to 4 percentage points due to finalization of the Basel III framework slated to be introduced in March 2025. Even so, we believe the two groups have secured sufficient capital buffers. Furthermore, we think these two groups have sufficient liquidity assets to cover liquidity demand because they hold cash and Japanese government bonds in their trading assets.

Table 1

Nomura Holdings and Daiwa Securities Group capital ratio and liquidity ratio comparison
Nomura Holdings Inc. Daiwa Securities Group Inc.
CET1 16.2% (March 2023) 18.36% (Dec. 2022)
S&PGR-assessed RAC (Sept. 2022) 13.0% 12.0%
Liquidity coverage ratio (LCR) 203.8% 135.9%
CET1--common equity tier 1 capital. RAC--risk-adjusted capital.

Table 2

Japan's major securities groups summary of financial results
SMBC Nikko Securities Inc. Daiwa Securities Group Inc. Nomura Holdings Inc. Mizuho Securities Co. Ltd. Mitsubishi UFJ Securities Holdings
(Mil. ¥) Fiscal 2022 Growth (%) Fiscal 2022 Growth (%) Fiscal 2022 Growth (%) Fiscal 2022 Growth (%) Fiscal 2022 Growth (%)
Commissions 159,130 (29.9) 279,991 (10.8) 664,749 (11.6) 161,084 (22.9) 151,850 (8.8)
Brokerage commission 28,164 (35.5) 64,272 (15.3) 208,700 (18.0) 29,746 (9.3) 23,241 (12.8)
Underwriting and secondary offering commissions 17,633 (56.3) 28,165 (28.2) 40,000 (36.4) 29,024 (35.8) 26,896 (26.7)
Distribution commission 17,554 (61.3) 11,316 (47.2) 30,300 (30.7) 29,681 (47.0) 18,628 (30.4)
Other commission 95,777 (1.9) 176,237 (0.7) 385,749 (1.3) 72,633 (2.9) 83,085 8.9
Net gain on trading 62,728 (39.3) 70,253 (30.8) 563,269 52.7 92,063 (10.5) 182,567 97.1
Financial income/expense 1,027 (74.1) 64,050 104.9 (36,459) (167.4) 25,309 4.2 17,835 (63.7)
Other (7) (107.5) 49,932 (9.6) 144,018 (23.8) 2,160 594.5 5 0.0
Net revenue 222,878 (33.3) 464,226 (7.5) 1,335,577 (2.1) 280,616 (16.4) 352,257 14.3
SGA 267,364 (2.9) 397,952 2.9 1,186,103 4.3 263,992 (0.9) 297,741 4.4
Pretax income (57,796) (189.4) 96,766 (31.7) 149,474 (34.0) (23,522) (136.5) 82,984 77.3
Net income (39,838) (180.0) 63,875 (32.7) 92,786 (35.1) 6,494 (88.2) 44,802 160.3
Cost to income ratio (%)* 120 37.6 86 8.7 89 5.4 94 14.7 85 (8.0)
Client assets§ (Tril. ¥) 68 (0.6) 75 (0.5) 122 0.1 50 (2.4) 46 7.2
Combined basis net revenue - - - - - - 506,700 - 417,000 -
Combined basis ordinary income (61,800) (189.8) - - - - 111,600 (14.7) 85,600 27.0
*Cost-to-income ratio growth is in percentage points. §Client assets: The balance indicates that of Daiwa Securities for Daiwa Securities Group; Nomura Securities for Nomura Holdings; Mitsubishi UFJ Morgan Stanley for Mitsubishi UFJ Securities Holdings. Note: Combined basis, including major overseas bases not included in the scope of consolidation.

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This report does not constitute a rating action.

Primary Credit Analyst:Chizuru Tateno, Tokyo + 81 3 4550 8578;
Secondary Contacts:Eiji Kubo, Tokyo + 81 3 4550 8750;
Satoru Matsumoto, Tokyo + 81 3 4550 8673;
Nakaba Arimitsu, Tokyo + 81 3 4550 8717;

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