Scott B. MacDonald
Banks – And Now Comes the Hard Part: The most
recent earnings season for Japanese banks was the best in years.
Helped by an economic rebound, a higher Nikkei, and sustained
pressure by the government to clean up bad loans, the major
banks (with the notable exception of UFJ) posted solid earnings.
Now comes the hard part. As the banks look into the current
fiscal year that ends March 31, 2005, they have to find ways
to make money. That is going to be a challenge. Lending alone
will not provide a platform for the generation of strong profits.
While loans to small and medium-sized companies and individuals
through credit cards are rising, total lending fell each month
since the Bank of Japan began tracking the figures in January
There are three reasons for the decline in bank lending and the ongoing difficult
nature of the market. First, auto, electronics and other manufacturing companies
are cutting their borrowings as they move production to China to reduce costs.
Second, utilities are slashing expenditures on new units to prepare for greater
competition in the domestic energy markets. Third, most of Japan’s top
corporations, with investment grade ratings, are seeking fewer loans. Instead
many of these companies are tapping stock and bond markets in Japan. They are
also willing to tap foreign bond markets for cheaper funds. The impact of all
three trends is to reduce loan demand and credit spreads, while loan margins
are shrinking due to competition.
What is the solution for Japanese banks? The answer is a greater movement into
investment banking and other fee-advisory services. The banks can also charge
the borrowers more, though may only accelerate the shift into non-bank finance
venues. U.S. banks have long made the shift to offering non-lending fee income
driven business. Almost 32% of Citigroup’s record $5.27 billion net income
for Q1 2004 came from its global investment banking business, while half of
the profit came from its global consumer finance unit, including credit card
operations. In contrast, two-thirds of Mizuho’s year-end 2004 gross profit
was generated from its lending business, while non-bank fee income was only
13%. The weakness in the fee income side of the business is evident by the
following: Mizuho ranks 8th in equities underwriting, 10th in local mergers & acquisitions
advising and 3rd in bonds underwriting.
March 31, 2005 is still far in the distance. Most major Japanese banks are
still enjoying the success of last year. However, the path forward is going
to be very challenging. Japanese banks have considerable work ahead of them.
Although non-performing loans have fallen, they remain an issue. In addition,
the pace of economic growth could slow, making the business environment more
difficult. Consequently, we think that Japanese banks are making a lot of progress,
but making good profits in the year ahead is going to be even more challenging.
Pension Reform Ruckus: In early June,
opposition lawmakers attempted to pull a ruling Liberal
Democratic party (LDP) legislator from a podium in the
Diet to prevent him from announcing the passage of a
bill seeking to reform Japan's troubled pension system.
Despite the effort on the part of the opposition members
of the Diet, committee head Masayuki Kunii managed to
announce the bill had been approved by a majority in
the upper house committee. Pension reform has been a
heated issue in Japan as the government is proposing
to cut benefits and raise premiums. Adding tension to
the issue, a number of Japanese politicians confessed
to missing pension premium payments, including Prime
Minister Koizumi and one-third of his Cabinet. In addition,
two top politicians stepped down from their posts after
it was revealed they had also skipped pension payments
in the past. Katsuya Okada, head of Japan's largest opposition
Democratic Party, pledged to try to block the legislation
at all costs. Committee approval clears the way for the
bill to be enacted into law by the full chamber, where
Koizumi's LDP and coalition partner New Komeito, enjoy
The Diet has been debating how to save the pension system from insolvency,
which is set to become a major election issue in the July contest for the upper
house of the Diet. Japan's society is rapidly aging and many are apprehensive
the smaller work force of the future will not generate a high enough level
of premium payments to supply pensions to the growing ranks of retired people.
North Korea – New Talks Scheduled: A
new round of six-nation talks seeking to end North Korea's
nuclear weapons programs will commence in Beijing on
June 23. The third round of six-nation talks will be
preceded by two days of preliminary negotiations involving
lower-level officials. Two previous rounds of high-level
talks ended without any breakthroughs in settling the
standoff, which flared in October 2002 when the United
States said North Korea admitted operating a secret nuclear
program in violation of a 1994 agreement. Washington
and its allies have been attempting to arrange a new
round of six-nation talks also involving the two Koreas,
host China, Japan and Russia by July, which was agreed
on by the nations when they last met in Beijing in February.
After the second round in February, the six nations held
their first lower-level meeting last month. The so called "working
group" discussions are envisioned as trying to smooth
the way and create an agenda for a third round of high-level