Japanese mega banks' core profitability lacks momentum: Fitch Ratings

NIMs are sitll under pressure.

It has been noted that the latest full-year financial results for Japan's "mega" banks underscore how overseas operations are growing in importance and helping to lift profitability.

According to a release from Fitch Ratings, however, foreign expansion - especially in emerging markets - will entail incremental risk-taking which will need to be supported by higher levels of capital.

Fitch Ratings maintains that it would be credit negative if loss-absorption buffers are not maintained to reflect increased risk appetite.

Japan's three largest banks - MUFG, SMFG and Mizuho Financial Group - recently reported slightly lower net profit (-4.2% yoy) on aggregate for the financial year ending March 2015 (FYE15).

The slowdown from the prior fiscal year was largely attributed to a decline in securities trading-linked profits, but shrinking net interest margins (NIM) in their domestic business and increased credit costs were also a feature.

Here's more from Fitch Ratings:

The results were largely in line with Fitch's expectations, as outlined in our 2015 Outlook report. Japan's megabanks continue to be challenged by the lack of any significant, sustained acceleration in the real economy, with initial Abenomics-related gains expected to taper off through FYE16.

Core profitability also lacks momentum, with NIMs remaining under pressure owing to a low-interest-rate environment and intense competition.

Aggregate net profit of the three megabanks is down, while MUFG registered a Japan-high net profit in excess of JPY1trn, but this was mainly attributable to contributions from its Thailand subsidiary Bank of Ayudhya.

Contributions to profit and operations from outside of Japan continue to rise in importance for all three. International operations account for 29%, 20% and 25% (estimated) of gross operating profit while international loans account for 37%, 28% and 24% of total loans, for MUFG, SMFG and Mizuho, respectively.

These banks are classified as Global Systemically Important Financial Institutions, and have established operations in developed markets - notably, MUFG's ownership of Union Bank in the US and its 21.9% stake in Morgan Stanley.

However, much of their expansion focus appears to be with their regional franchises in Asia-Pacific - and particularly in emerging markets, to capture growth opportunities.

As such, Japanese banks' overseas expansion will entail greater risk-taking not only related to credit but also operational and market risk. This means additional foreign-currency exposures and the likelihood of having to tap more wholesale sources for funding. Effectively controlling risk & return from their growing overseas businesses will be a key challenge.

For now, Japan's megabanks maintain adequate capital adequacy, solid asset quality and stable financial results, and the current stable rating outlooks are well supported.

Measures to boost capital ratios, such as the issuance of additional Tier 1 capital, have not yet been fully outlined, but additional capital-raising would help to keep banks on a par with their global peers.