Japan Banks - Big profit delta
Low ROA base can mean bigger delta than others in Asia
We all know how bank earnings can swell with lower credit costs. We have seen in most all regions globally, although less so Asia-Pacific. But lower credit costs alone should not be the only point of analysis, but rather how this can improve ROA. This is where Japan’s banks shine: their ROA is so incredibly low, even a slight improvement in credit costs can be significant for the ROA delta.
There is one bank that stands out from the better known mega banks. This bank is Daishi Hokuetsu Financial Group (7327). There is no bank that is larger in net loans where credit costs remain far higher now than recent years. MUFG reports 2bps credit costs/loans in the latest quarter compared with 48bps in the most recent fiscal year. SMFG reports 5bps credit costs/loans in the most recent quarter compared with 43bps in the most recent fiscal year.
Daishi Hokuetsu though is unlike large peer banks. This regional bank reports 23bps credit costs/loans in the most recent quarter compared with 10bps in the most recent fiscal year and 14bps in the preceding year. There is no demonstrable worsening of credit metrics, suggesting the bank remains overly conservative, and that credit costs can come in dramatically in coming quarters.
Where Daishi Hokuetsu has an ROA of only 18bps in the most recent quarter, lower credit costs can have an oversized impact to profit growth. The large mega banks have ROA of 34-45bps in the most recent quarter, by way of comparison. Daishi Hokuetsu took JPY2.8bn in total impairments during 1Q22 compared with JPY474m in the preceding quarter. Its reported bad loans rose less than 10% in the quarter; there is nothing in its NPL data indicating that credit costs should be raised by 5.9x in the period. This will not be the first time a bank has over-provisioned.
Where the bank’s credit costs are now 30% of operating income, the leverage to earnings from lower credit costs is clear. The figure was close to 0% in 4Q21 and closer to 20% in 2Q21. There is certainly a limited history of this bank, which was formed recently from the combination of two banks. This is besides the point, and we view this as ‘white noise’ which is not something that we tend to focus on. What matters now is 1) where we are in the cycle, 2) the level of the bank’s ROA, and 3) the outlook for future credit costs compared with their current level.
Our friend at Asian Century Stocks, Michael Fritzell recently produced a compelling chart similar to the below, suggesting that Japan can see far stronger economic growth in coming quarters. We extrapolate this to banks, which ultimately rely on the delta in the economic outlook for their credit costs; for their calculations of probability of default (PD) and loss given default (LGD). While we all have fatigue from vax analysis, it remains hugely relevant, and especially to banks.
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