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In addition to being big Japanese government-bond buyers, Japan’s megabanks are also (wait for it) heavily invested in equities. Though not as much as they used to be.
There’s a slightly ironic backstory here that has to do with Japan’s very long banking crisis. During the bubble years, Japanese banks rushed to invest in the country’s booming stock market — often booking any share price gains as ‘unrealised gains’ or ‘hidden reserves’ that fed into their regulatory capital. Once the market crashed, the banks posted huge equity losses. The financials subsequently cut down on their share holdings (relatively) and Japan’s regulators reacted with some new rules.
With the Topix and the Nikkei 225 down almost 10 and 11 per cent this Tuesday, respectively– it’s worth asking whether history is about to repeat itself.
And while the regulatory situation may be slightly different, the theme is the same.
Here’s CreditSights on the subject:
In mid-session on Tuesday 15 March the Topix index was at 787, down almost 20% from its February peak. This means that as of now the megabanks probably no longer have aggregate net unrealised gains on their equity holdings, and are now facing unrealised losses. As far as regulatory capital is concerned there is an “asymmetric” treatment in that unrealised gains are not counted as Tier 1 capital but unrealised losses (net of tax) are deducted from Tier 1. (There is currently an exemption for banks operating under the less demanding domestic standard for capital adequacy). It is also likely that the banks would have to take some impairment charges through the income statement on stocks whose value had fallen particularly sharply, which would directly impact their common equity. Note that a key issue is how they value their equity holdings, ie whether they simply use the value as at 31st March or the monthly average for March. Normally the difference would be small but as the plunge has happened in the middle of the month the difference this time could well be very large. We understand Mizuho and SMFG use the monthly average method while MUFG uses month-end values.
In summary, the current level of stock prices would, if sustained until their financial year-end at the end of March, eliminate the megabnks’ net unrealised gains (but only reduce them if the monthly stock average is used) and cause some valuation losses to be taken through the income statement, reducing their net profit for the year. If the Topix index bounces back above 800 the scale of such losses should be limited. If the index continues to plunge then the scale of the losses would grow. Our estimate, which can only be very approximate, is that a drop to 700 would lead to net unrealised losses of around JPY300bln (or JPY200 bln net of tax) for Mizuho, u.e. just under 5% of its Tier 1 capital. The figures for its two peers should be slightly smaller in relation to their capital. The stock market would have to fall a very long way to seriously reduce their regulatory capital but its volatility is a reminder of the risks the Japanese banks still face and complicated their efforts to build capital for Basel 3 compliance.Their legacy equity holdings have been “grandfathered” for capital purposes, receiving only a 100% risk weighting (i.e. capital charge 8%) for a 10 year period ending in 2014. As we noted yesterday … if bond prices also fall back while the stock market remains low, then the banks’ total investment portfolios may be under water — a dramatic change from the large unrealised gains they enjoyed only months ago.
Dramatic? Sounds like a tragedy to us.
Related links: Japanese banks: burning nicely - The Economist, 1997 Super-catastrophe and super-banking risk – FT Alphaville
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