No. 22 — June 9, 2000


Weekly Review

--- by Jon Choy

Japan's top commercial banks posted much-improved business results for the fiscal year ending March 31, 2000. All but one institution reported a return to profitability after taxes. Moreover, expenses related to writing off nonperforming assets fell by more than half from FY 1998's total, and the amount of bad loans still on bank books shrank. Executives trumpeted these three developments, arguing that they are well on their way to restoring the financial health of their companies. This news, combined with the planned consolidation of Japan's major banks (see JEI Report No. 17B, April 28, 2000), means that the domestic banking industry will be better prepared for increasing competition from foreign rivals and other domestic financial services providers.

While acknowledging the bright spots in big banks' FY 1999 results, observers remain cautious about the institutions' prospects. Annual forecasts of industry executives, these analysts say, consistently have underestimated the amount of money needed to dispose of soured loans. Skepticism also remains high with regard to banks' calculations of their total nonperforming loans; many experts suspect that bankers are refusing to admit the financial problems of troubled borrowers or the economy's uncertain prospects. Furthermore, analysts argue that banks' FY 1999 profits relied on a run-up of stock prices at the end of the fiscal year — a boon that could prove fleeting. As for banks' merger and restructuring plans, observers hotly debate the potential for cost savings as well as the time line for realizing possible economies.

With the exception of troubled Nippon Trust Bank, Ltd. — which reported a loss of ¥13.6 billion ($123.6 million at ¥110=$1.00) — Japan's elite banks all earned after-tax profits in FY 1999. Ranging from Fuji Bank, Ltd.'s high of ¥102.1 billion ($928.2 million) to Toyo Trust & Banking Co., Ltd.'s low of ¥7.8 billion ($70.9 million), the black ink was a welcome change from the after-tax losses posted in FY 1998 by 15 of the then-top 17 banks (see JEI Report No. 22B, June 11, 1999).

More telling, however, were the pretax numbers (see Table 1). Six institutions reported declines in net income from core operations, ranging from minus 11.8 percent (Mitsui Trust & Banking Co., Ltd.) to minus 50.3 percent (Yasuda Trust & Banking Co., Ltd.). Of the 11 lenders showing gains, three — Industrial Bank of Japan, Ltd., Mitsubishi Trust & Banking Corp. and Toyo Trust & Banking — came in at less than 5 percent, while the rest enjoyed significant increases of 32.5 percent to 182 percent.

When net nonoperating revenues are included but before taxes are calculated, all but two of Japan's major banks had a positive bottom line in FY 1999 compared with none the year before. One factor contributing to this improved performance was profits from the sale of stock. As a group, leading lenders had sold shares by the end of FY 1999 that had an estimated book value of ¥2.3 trillion ($20.9 billion). The majority of this stock consisted of cross-held shares, bought as a goodwill gesture to business partners and traditionally not sold.

Two factors, however, encouraged banks to unload a record amount of cross-shareholdings. First, new accounting rules in force for FY 1999's full-year financial statements required investment portfolios to be valued at current market prices. This rule made it much harder for banks to disguise the true worth of their stock holdings and created an incentive to sell underperforming equities. Second, Japanese share prices staged a rally at the end of FY 1999 (see JEI Report No. 14B, April 7, 2000), leading banks to sell not only their laggard stocks but the strong ones as well in order to realize capital gains. However, true performers were bought back by banks immediately after being sold; weak shares were not.

Across the board, the cost of removing bad loans from the balance sheets of top banks dropped sharply in FY 1999, falling to roughly ¥4.4 trillion ($40 billion) from ¥10.4 trillion ($94.5 billion) a year earlier. Bankers forecast another steep cut in this expense in FY 2000 (see Table 2) — an assertion questioned by industry watchers, who point out that similar claims in the past proved far too optimistic.

In FY 1999, banks appeared through the first half of the fiscal year to be on track to lower their bad-loan costs (see JEI Report No. 46B, December 10, 1999). However, they suffered setbacks during the October 1999-March 2000 period, when some big customers went bankrupt (such as retailer Nagasakiya Co., Ltd.) or petitioned lenders for debt forgiveness (department store operator Sogo Co., Ltd., for one). Until a recovery takes firm hold, experts warn, lenders will continue to be hit with unexpected failures, such as the recent collapse of Life Co., Ltd., a consumer-credit company with nearly ¥970 billion ($8.8 billion) in debts.

Another potential problem that bankers are not discussing is the large number of golfing facilities that are bankrupt or nearly so. Built during the heady days of the late 1980s' "bubble economy," these clubs sold memberships at astronomical prices, con-vincing buyers that demand for memberships would continue to outstrip supply and equating the required noninterest-bearing deposits of dues to investments that would yield significant capital gains over their 10-year term. After a decade of stagnation, however, the value of most memberships has fallen in step with property prices. Many golf clubs are bankrupt or close to that point, making it unlikely that they will be able to pay back the rapidly growing number of investors who want to redeem their membership deposits. Having lent money to build the golf courses and extended credit to individuals for member-ships, banks will be on the losing end of this problem in two ways. With as much as several trillion yen involved, some analysts warn that this situation could mushroom into a major crisis.

Observers also dis-parage the role of stock portfolio gains in banks' FY 1999 results. Since March 31, Japanese equity prices have taken a beating. For example, the benchmark Nikkei average of 225 shares traded on the first section of the Tokyo Stock Exchange is off more than 20 percent from its FY 1999 close. If banks had to use today's market prices to value their portfolios, analysts say that their bottom lines would look very different.

In preparation for the mergers and combinations planned by most of Japan's top banks, analysts have rearranged the business results of individual institutions to obtain some idea of the pending groups' potential performances. A clear picture is elusive, however, because the scenarios vary in their details. Leading business daily Nihon Keizai Shimbun estimates, for example, that the Mizuho Financial Group — the proposed union of Industrial Bank of Japan, Dai-Ichi Kangyo Bank, Ltd., Fuji Bank and Toyo Trust & Banking — would have had a 3.7 percent return on equity in FY 1999. Japan's business and technology newspaper, Nikkan Kogyo Shimbun, and the daily Asahi Shimbun, in contrast, come up with a return on equity of 4.2 percent for what will be the world's largest bank.

Another measure bandied about is net operating income per employee. While the estimates vary, there seems to be general agreement that the Mizuho Financial Group would rank first by this measure, followed by Sumitomo Mitsui Banking Corp., the Mitsubishi Tokyo Financial Group and the Sanwa/Tokai/ Asahi Group.

The business sense of these groupings and their potential impact are subjects of active debate. Two questions are of greatest interest. First, will the proposed combinations yield the economies and the synergies claimed by the participants? Observers point out that some proposed groups are having trouble focusing and developing a clear leadership structure, leaving them open to criticism that they lack a precise and viable business plan.

How to figure exactly when the claimed merger benefits will be realized is another point of contention. Most analysts think that it will be some time before cost savings can be achieved since tough decisions about reducing staff, streamlining branches, unifying computer systems and combining operations are not likely to be made swiftly. Others are even more pessimistic, pointing out that vestiges of the two banks that merged to form Dai-Ichi Kangyo Bank in 1971 still exist, adding to costs and reducing efficiency.

Not everyone agrees that the proposed groupings will give Japanese banks a leg up in a business that is becoming fully globalized. Bigger, many analysts say, is not necessarily better.

The views expressed in this report are those of the author
and do not necessarily represent those of the Japan Economic Institute

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