Fitch: Japanese investment banks return to profit

Agency still cautious as Europe's sovereign credit crisis can pull down anemic growth of Japanese lenders.

Fitch Ratings on Wednesday said, in a new special report, that while major Japanese investment banks returned to profitability in the financial year to end-March 2010 (FYE10), profits remained weak. The agency notes that the increased focus on overseas expansion by the Japanese investment banks could diversify revenue stream and lead to revenue and earnings growth, but these banks will face challenges in the form of intense competition from established players. Furthermore, considering the market downturn brought on by sovereign credit concerns in parts of Europe, the uncertainty as to how long the crisis will persist, as well as the expected slowdown in some key earnings drivers in FYE10, the agency maintains a cautious outlook for the Japanese investment banking industry through FYE11 and beyond.

"The massive amounts of capital raised by major financial institutions and general business corporations in FYE10 will unlikely be repeated, so the equity underwriting fees will moderate from the high levels of the previous year. Meanwhile, other business lines in retail and wholesale brokerage are not expected to grow strongly either in FYE11," said Ehsan Syed, Director in Fitch's Financial Institutions ratings team in Tokyo. In addition, the increase in market volatility brought on by the sovereign credit woes in Europe could impact trading gains and the overall market sentiment, especially if the crisis persists and/or worsens. That said, the agency expects the direct impact on Japanese investment banks to be limited.

The big two independent investment banking groups, Nomura Holdings Inc. (NHI; 'BBB'/Positive) and Daiwa Securities Group Inc. (DSGI; 'BBB+'/Negative), and their core broker-dealer subsidiaries, Nomura Securities Co., Ltd. (Nomura Securities; BBB+/Positive) and Daiwa Securities Capital Markets Co., Ltd. (Daiwa Capital Markets; 'A-' /Negative) all returned to profitability in FYE10, along with three bank-affiliated securities firms, the former Mitsubishi UFJ Securities Co. Ltd., Nikko Cordial Securities Inc., and Mizuho Securities Co. Ltd.

The quick recovery in economic growth in Asia after the financial crisis which began in autumn 2008, aided by the governments' fiscal stimulus had a positive impact on the overall market sentiment in Japan in FYE10. Trading gains across equity, fixed income and other segments grew in FYE10, as market volatility fell from the abnormally high levels of the previous year. A favourable operating market for various business lines in the wholesale and retail businesses, in particular, the equity underwriting, new investment trusts sales and trading gains helped restore bottom-line profitability across the board.

Fitch notes that while the Nikkei 225 stock market index rose by 37% during FYE10, it has since shed 14% as of 26 May 2010 compared to the closing peak of 11,089.94 on 31 March 2010. The market declines brought on by the sovereign credit concerns in parts of Europe and the continued deflationary pressure, signify the challenges in both market and macroeconomic conditions. The weakening financial market sentiment could impact other business lines in retail and wholesale, and potentially even reduce the risk appetite of Japanese retail customers for investment trust products -- a business segment that grew strongly in FYE10.

The agency says that the increased focus on overseas expansion by the big two investment banking groups, in particular, could contribute to the strengthening of their global franchise and revenue diversity in the medium-to-long term, although this might pressure their near-term performances. These groups have followed conservative capital and financing strategies, and if appropriate risk management policies are implemented, the revenue diversity and reduced economic exposure to Japan would be positive for their credit profiles.

In the report, Fitch also comments on the realignments within the Japanese mega-banking groups' affiliated securities firms and how the reorganisation within this segment is changing competitive dynamics of the industry. Amid falling loan balances and near zero interest rates, the Japanese mega-banks have increased their focus on securities business as they look for new areas of earnings growth. Fitch expects the competition for the securities business to move beyond the domestic market, as the bank-affiliated securities firms are also strengthening their overseas operations.