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Shrinking Yield Curve Crushes Japan’s Bank share index


May 18, 2016

    The Bank of Japan’s <BoJ> surprise decision on January 29th -to charge lenders for some of their reserves has made banks the worst performers on the Tokyo Stock Exchange this year and led to criticism from bank executives and analysts. The Topix Banks Index has tumbled –45% compared last year’s peak levels, the most of all industry groups. MUFG, the nation’s biggest lender, dropped -33%, Sumitomo Mitsui declined -27% and Mizuho slid -31%.

    Since Japan’s central bank began charging lenders 0.1 percent for some of their excess reserves in February, the yield spread between Japan’s 10-year versus 2-year – has contracted further, to as little as +14-bps today, which in turn, is reducing banks’ interest income while doing little to fuel credit growth.

    The bank industry’s net interest income, or revenue from lending minus payments on deposits, fell to a record low +120-basis points <bps>, among the lowest in the world. Citigroup’s analysts were quick to note that the BoJ’s action would push down yields on variable rate loans that make up about 90% of Japanese domestic lending – that would eventually be repriced lower, with the possibility that interest-rate competition could intensify, and further reducing their net profitability. Loan profitability will erode further because lenders won’t be able to pass on negative rates to depositors, Mitsubishi UFJ Financial Group <MUFG> President Nobuyuki Hirano said in a speech last month that railed at the BoJ’s policy.

    The banks have no option but to keep voicing their opposition’’ to NIRP, as the Topix Banks Index has been the worst performer among 33 industry groups on the nation’s benchmark stock gauge. Japan’s largest bank, Mitsubishi UFJ Financial Group sees its full-year profit falling -11% as negative interest rates squeeze loan profitability and bad-loan costs increase. MUFG’s outlook is also hampered by the risk of soured loans to the energy industry even as oil prices recover from a two-year rout. “The severe environment with ultra-low interest rates is continuing under the negative interest-rate policy,’’ Hirano, 64, said.

    Negative interest rates will have an impact of at least ¥40-billion on this year’s earnings, Mizuho Chief Executive Officer Yasuhiro Sato said at a briefing in Tokyo. Sumitomo Mitsui sees a ¥20-billion effect on pretax profit, President Koichi Miyata told reporters.

    The results cap off an earnings season that saw Japan’s three biggest lenders — MUFG, Sumitomo Mitsui Financial Group Inc. and Mizuho Financial Group Inc. — project a combined 2.15 trillion yen in profit in the year ending March, or -5.2% lower than last year. MUFJ, the nation’s biggest lender, reported a -8% drop in group net profit to 951-billion yen due to low profit margins on lending and bad loan expenses. In the current business year, MUFG expects around a 100-billion yen impact on profit from the negative interest rates introduced in January by the BOJ. SMFG’s group net profit dropped -14.2% to 647-billion yen due to the booking of expenses for future interest rate refund claims in its consumer finance business. Resona’s net profit fell -13.1% to 184-billion yen.

    But some analysts anticipate less of a hit to banks’ profits. “The hit to commercial banks’ profits will be limited, as the Bank will continue to pay a positive rate on the bulk of existing central bank reserves,” said economists at Capital Economics. “Even if the BoJ lowered rates to negative 1 percent, commercial lenders’ annual loss would be only around 300 billion yen, or about 4% of annual profits.

    Looking at the flip side – the BoJ is also buying ¥6.5-trillion of Japanese government bonds (JGBs) each month, and Japanese banks can sel their vase holdings of JGB’s to the central bank at higher prices. Prices of JGB’s jumped after the adoption of negative rates, pushing up the value of commercial banks’ substantial bond holdings. The potential profit MUFG could book by selling its domestic bond holdings including JGBs was about 550-billion yen ($5.1-billion) as of the end of March, from 317-billion yen at the end of September, according to banking analysts at Deutsche Securities. The unrealized gain on such holdings at Mizuho and SMFG is about 100 billion yen each. The three mega banks’ net profit would increase if they sell JGBs,” he said.

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