Sharp’s Malaise Risks Bad-Loan Surge at Megabanks: Japan Credit

Japan’s biggest banks are spending the least amount to cover losses on bad loans this century. That could change as they step up lending to the nation’s ailing electronics companies including Sharp Corp. (6753)

The average ratio of reserves for delinquent debt at 84 lenders on the Topix Banks Index (TPNBNK) has dropped to 1.4 percent of total loans, the lowest in at least 12 years, according to data compiled by Bloomberg based on the latest filings. That’s less than half the level in 2000, when the industry was emerging from a financial crisis, and is smaller than the 1.85 percent average for 24 U.S. lenders on the KBW Bank Index. (BKX)

Banks including Mizuho Financial Group Inc. (8411) are lending to non-investment grade companies such as Sharp to widen record-low net interest margins after cleaning up bad debts that peaked at 43 trillion yen ($542 billion) in 2002. The danger is that borrowers will fail to turn that credit into profit, boosting default risk and eroding bank earnings already under pressure from losses on their 16.2 trillion yen of stock holdings.

“The severe environment surrounding the electronics industry could increase banks’ credit costs to some extent,” said Takayuki Atake, chief credit analyst at SMBC Nikko Securities Inc. in Tokyo. “Impairment losses from stocks, in particular of electronics-related equities, will have a big impact on the earnings of banks like Mizuho.”

Economic Slowdown

Japanese electronics makers including Sharp and Panasonic Corp. are reeling from increased global competition, slowing economic growth and a yen rate that’s 5 percent from a postwar high against the dollar. The government has downgraded its view of the world’s third-largest economy for three straight months as exports weaken. Overseas shipments fell more than economists forecast last month, government data showed today.

Sharp secured 360 billion yen of funding from units of Mizuho and Mitsubishi UFJ Financial Group Inc. (8306) last month after the television manufacturer pledged to cut more than 10,000 jobs and sell plants. Panasonic, which is trying to recover from a record annual loss, said Oct. 16 that it got 600 billion yen in credit lines from lenders including Sumitomo Mitsui Banking Corp. and Bank of Tokyo-Mitsubishi UFJ Ltd.

Mizuho, Sumitomo Mitsui and Bank of Tokyo-Mitsubishi are also lending about 1.5 trillion yen to Softbank Corp. (9984) for the wireless operator’s $20 billion bid to buy control of Sprint Nextel Corp. in the biggest publicly announced outbound acquisition by a Japanese company since at least 2000. Moody’s Investors Service and Standard & Poor’s have said they may cut Softbank’s credit rating because of the deal. Moody’s rates Japan’s third-biggest carrier one level above junk and S&P has it at the second-lowest investment grade.

Impact Abroad

“Domestic factors alone won’t raise banks’ credit costs,” Japanese Bankers Association Chairman Yasuhiro Sato said at a news conference on Oct. 18. “However, we must closely watch any impact on Japanese machine-parts makers and smaller businesses from any adverse effects abroad,” said Sato, who is also chief executive officer of Mizuho.

The bursting of Japan’s real estate and stock bubble more than 20 years ago led to the collapse of Yamaichi Securities Co. and Hokkaido Takushoku Bank and prompted other lenders ridden with bad debts to form the three so-called megabanks that exist today. Non-performing loans reached a record 43.2 trillion yen as of March 2002, according to Financial Services Agency data.

Banks’ provisions for bad debts peaked at 15.5 trillion yen in May 2000, Bank of Japan figures show. They have pared reserves since then, setting aside 4.95 trillion yen as of August, close to a record-low 4.85 trillion yen in March.

Shinsei Sale

Elsewhere in the domestic credit markets, Shinsei Bank Ltd. sold 6.4 billion yen of 10-year subordinated bonds. The Japanese lender partly owned by J. Christopher Flowers priced the notes to yield 4 percent for the first five years, after which the charge switches to 3.61 percentage points more than the five- year yen swap rate, according to data compiled by Bloomberg.

Sekisui House Ltd., the Osaka, Japan-based home builder, hired banks for an offering of about 20 billion yen of five-year notes, according to a statement from Mitsubishi UFJ Morgan Stanley Securities Co., which is managing the deal together with Mizuho and SMBC Nikko.

Japan’s corporate bonds have handed investors a 1.4 percent return this year, compared with the 1.7 percent gain for the nation’s sovereign debt, according to Bank of America Merrill Lynch data. Company notes worldwide have gained 9.8 percent, according to the data.

Default Risk

The Markit iTraxx Japan index of credit-default swaps for 50 companies declined 15 basis points last week to 208 on Oct. 19, after falling to the lowest since Sept. 19 the previous day, according to data provider CMA, which is owned by McGraw-Hill Cos. and compiles prices quoted by dealers in the privately negotiated market. A decrease in the contracts signals improving perceptions of creditworthiness, while an increase suggests the opposite.

Yields on Japan’s benchmark 10-year government bonds gained 1 1/2 basis points compared with Oct. 12 to 0.78 percent today. The securities yielded 98 basis points less than similar maturity U.S. Treasuries, versus 114 basis points a year earlier.

The yen traded at 79.33 per dollar at 9:54 a.m. in Tokyo, after weakening 1.1 percent last week. The Japanese currency strengthened to a post-World War II record of 75.35 on Oct. 31.

Exports Fall

Japan’s exports slid 10.3 percent in September from a year earlier, the Finance Ministry said in Tokyo today. Economists expected a 9.9 percent export decline, according to median forecasts in surveys by Bloomberg News. A rising yen erodes exporter profits by making their products more expensive abroad and reducing the value of repatriated earnings.

Japanese lenders are also vulnerable to losses from stocks they hold as part of a culture of companies taking stakes in each other to cement ties. Banks have been sluggish in paring their shares of allied enterprises, according to Naoko Nemoto, a director of financial institutions ratings at S&P in Tokyo.

“The slow pace of unwinding cross-shareholding is keeping the risk of equity volatility intact for megabanks,” Nemoto said. Stricter bank capital rules developed since the global financial crisis “will perhaps prompt them to accelerate the pace of cutting allied shareholdings to mitigate the risk.”

Stock Loss

Mizuho, the nation’s third-biggest bank by market value, said on Oct. 5 that it will book 173.7 billion yen in losses relating to declining values of its domestic stock holdings in the three months ended Sept. 30. Mizuho’s corporate lending unit has shares in Sharp, which has tumbled 76 percent this year, the worst performance among 1,672 companies on the Topix Index.

“Declines in Japanese electric utility and electrical appliance manufacturer stocks fueled the losses, and we expect the other megabanks to experience similar results,” Moody’s wrote on Oct. 11. The portfolio losses are credit negative for the three banks, it said.

Japanese lenders’ stock holdings fell to 16.2 trillion yen in August from 17.5 trillion yen a year earlier and a peak of 47.9 trillion yen in October 1997, Bank of Japan data show.

The emergency loans to Sharp signal that “banks in general aren’t easily able to cut transactions with big corporate clients even if their creditworthiness deteriorates,” said Shinichi Ina, a Tokyo-based analyst at UBS AG. “Blue-chip companies can suddenly get in trouble due to changes in the business environment, and banks still rely on domestic lending as their main source of revenue.”

To contact the reporters on this story: Shigeru Sato in Tokyo at ssato10@bloomberg.net; Takako Taniguchi in Tokyo at ttaniguchi4@bloomberg.net

To contact the editor responsible for this story: Chitra Somayaji at csomayaji@bloomberg.net

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