So far, Japanese banks have escaped practically unscathed from the subprime tsunami, but skeptics believe they just haven't 'fessed up yet
While banks in the U.S. and Europe are writing down billions of dollars in subprime losses, Japanese banks have been surprisingly stable. Japan's banking industry, hammered by the collapse of the nation's real estate bubble in the early 1990s, have not reported gigantic losses related to the collapse of the American real estate bubble of the mid-2000s. That's prompted some analysts to ask, Is it possible Japan's banks really do have relatively little exposure to the subprime tsunami that is wiping out billions in earnings at the likes of UBS (UBS), Merrill Lynch (MER), and Citigroup (C)?
Chief among the skeptics is Hans Redeker, currency chief at BNP Paribas (BNPP.PA). In a research note to clients early this month, he warned that Japan may be hiding billions of dollars in subprime losses that so far no one has admitted to owning. His argument is simple: Japan, as the world's largest creditor nation, plays a central role in pumping global liquidity, aided by its ultra-low interest rates. But its biggest banks, which include "megabanks" Mitsubishi UFJ Financial Group (MTU), Mizuho Financial Group (MFG), and Sumitomo Mitsui Financial Group (8316.T), have admitted to only $5 billion or so of subprime-related losses, a remarkably small figure considering the losses at American and European banks already run to more than $130 billion.
What's more, with some estimates putting the total subprime black hole at $400 billion to $500 billion, somebody somewhere could be sitting on $300 billion of subprime losses. Japan, in Redeker's view, is a suspect. "We think this is where the next big problem is going to pop up," he told Britain's Daily Telegraph newspaper, echoing comments he made in a research note to clients Feb. 1.
So Far, the Numbers Don't Look Bad
Japan's banks, backed by government data, insist that he's wrong. The Ministry of Finance reported Feb. 13 that Japanese institutions' total holdings of subprime investments at the end of December was $13.8 billion, an increase from $12.9 billion in September. Subprime losses, meanwhile, doubled to $5.6 billion during the same period. That's a tiny sum by global standards.
Indeed, for the big three banks, the numbers don't look especially damaging. Mitsubishi UFJ (MUFG), the world's biggest bank by assets, projects that for the year ending Mar. 30, its full-year subprime losses will be just $880 million, up from $510 million for the nine months ended December. "There is nothing to hide," a spokesman said in an e-mail to BusinessWeek. "We don't understand at all why they expect subprime-related losses of $300 billion [should be linked] to the Japanese banks."
No. 2 lender Mizuho says its subprime losses for the full year will increase to $3.7 billion after its securities arm ran up losses in the U.S. Mizuho also expects its net earnings to slip 24%, to $4.4 billion. Sumitomo Mitsui (SMFG), the third of the megabanks, projects its subprime losses for the financial year ending in March will run to $920 million, unchanged from December.
Tougher Reporting Requirements
Putting those numbers into context, Switzerland's UBS has written off $18.4 billion in subprime losses. Citigroup and Merrill Lynch have written off $18 billion and $14 billion, respectively. Clearly, it would take a huge turn of events for Japan to suddenly become the next subprime flash point. "I do not think Japanese banks have large subprime exposures," says Naoko Nemoto, managing director of Financial Service Ratings at Standard & Poor's in Tokyo. (S&P, like BusinessWeek, is owned by The McGraw-Hill Companies (MHP).)
Tokyo analysts add that it is highly unlikely Japan's banks are covering up losses, something they were guilty of in the dark days of the 1990s. One reason is that more stringent reporting requirements mean it's now more difficult to cover up problems even if banks wanted to. "There's no way for the Japanese to hide it unless they are outright lying," says Graeme Knowd, an analyst at CLSA in Tokyo.
Rather than suffer under growing subprime losses, Japan's big banks may see rivals' plight as an opportunity. Tellingly, Mizuho, Japan's worst-hit bank, participated in a bailout of Merrill Lynch on Jan. 16, investing $1.2 billion in return for a stake in the U.S. bank (BusinessWeek.com, 1/16/08). "This is just one of several factors that show concerns over subprime problems at Japanese banks are misplaced," says Hironari Nozaki, an analyst at Nikko Citigroup. Nozaki, who has "buy" ratings on all three megabanks, adds that similar deals by Japanese could follow in the near future.
Risk and Rates Come Into Play
Just as important, there are solid explanations for Japan's banks not being as deeply entwined in the subprime mess as Western rivals. First, after huge credit problems of their own in the '90s, Japan's big lenders may have shown little appetite for the kinds of risk offered by subprime investment. Indeed, Japan's banks, preoccupied with multiple mergers and huge systems integrations, have been criticized for being too risk-averse. Mizuho, arguably the most aggressive of the Big Three—and the bank with the biggest subprime losses—had won plaudits for showing a desire to increase its earnings power.
Second, ultra-low interest rates in Japan put less pressure on banks to seek higher-yielding securities. For much of the decade, Japan's overnight lending rates have been zero or near zero, significantly lower than U.S. and European rates. Consequently, Japanese banks could easily outperform returns in Tokyo without taking undue risk by investing heavily in subprime instruments. European banks, which faced higher interest rates at home and a rising euro, were not so fortunate.
But what of the "yen carry trade," the billions of dollars borrowed in Japan at near-zero interest rates and invested overseas in search of higher yields? CLSA's Knowd says much of the serious lending was made by non-Japanese banks, which then lent to hedge funds, rather than Japanese banks themselves buying up repackaged subprime assets. "The argument people would like to make is that the Japanese were the buyers of the absolute junk. It's incorrect," says Knowd, who rates MUFG and Mizuho "buy" and SMFG an "outperform."
Bank Stock Sell-Off
What is undisputed, though, is that Japanese bank stocks have been sold off heavily in recent months, in some cases more than troubled rivals. Since August, 2007, when subprime problems intensified, the stock prices of MUFG, Mizuho, and SMFG have fallen by 24%, 38%, and 25% respectively. Merrill Lynch, which fell 31% after running up billions in losses during the same period, has outperformed Mizuho.
Why should investors be so negative on Japan's bank stocks? One reason is Japan's sluggish economy. Some foreign investors expected Japan's interest rates, currently 0.5%, to rise more quickly as the economy recovered, boosting bank earnings. Disappointed, they've sold, depressing stock prices. The Japanese stock market has also suffered as global investors have reassessed risk profiles amid the subprime crisis.
There is also concern that assets other than subprime could hurt profits. Japan's major banks hold $54 billion in structured assets excluding subprime and agency asset-backed securities, and while much of those assets are rated triple-A by rating agencies, a worsening credit environment could yet lead to losses. "The subprime problem should not be a big threat, but downgrades of municipal bonds or rating major monoline insurance companies is a worrying issue," says Yasuhiro Matsumoto, an analyst at Shinsei Securities in Tokyo. Monoline insurers insure the principal and interest that underpin bonds and securitized debt instruments. The concern is the monolines themselves may be exposed to losses and unable to meet guarantees.
Yet for all that, suggestions that Japan's banks are sitting on a subprime bomb appear wide of the mark. Perhaps the bigger question is if Japan's banks don't explain away the hundreds of billions of dollars of unaccounted subprime losses, what does?