Lacklustre performance continues to hound Japanese major investment banks

Japanese lenders’ woes to continue until end of March 2011 as its fragile market sentiment and economic conditions persist.

Fitch Ratings has said on Wednesday in a new industry comment that it expects the profitability of the major Japanese investment banks to remain under pressure in the near term. It does not expect a strong recovery in the key wholesales business lines in the short term, amid fragile market sentiment and economic conditions. At the same time, the elevated cost bases at most of these investment banks, from expansionist strategies in the overseas/domestic markets, have raised breakeven points. Fitch continues to remain cautious on the outlook for the Japanese investment banking industry for the second half of the financial year to end-March 2011 (H2FYE11).

The operating performance of the major Japanese investment banks was lacklustre in H1FYE11, with profitability considerably weakened yoy. This reflected a depressed domestic stock market, a moderated equity underwriting business and an overall weak market environment that began with sovereign credit issues in parts of Europe in Q1FYE11, amidst elevated cost bases.

The 'Big Two' independent investment banking groups - Nomura Holdings, Inc. (NHI; 'BBB'/Positive) and Daiwa Securities Group Inc. (DSGI; 'BBB+'/Negative) - and their key broker-dealer subsidiaries, Nomura Securities Co., Ltd. (Nomura Securities; 'BBB+'/Positive), Daiwa Securities Capital Markets Co., Ltd. (Daiwa Capital Markets; 'A-'/Negative) and Daiwa Securities Co., Ltd. (Daiwa Securities; not rated) reported a drop in net operating revenue (NOR) in H1FYE11, as the weak capital markets environment affected business lines across the wholesale and retail segments (with a larger impact on wholesale business lines). While NHI, Nomura Securities and Daiwa Securities remained profitable, DSGI and Daiwa Capital Markets fell into net losses, according to a Fitch report.

Similar factors led to a drop in NOR for two of the three major commercial bank-affiliated securities companies, namely Mitsubishi UFJ Securities Holdings Co., Ltd. and Mizuho Securities Co., Ltd., Nikko Cordial Securities Inc., was the only firm to grow, in NOR terms, and this was attributed to an aggressive build-up of its wholesale brokerage platform. Net profit, however, fell at all three major bank-affiliated securities firms in H1FYE11.

Fitch is positive about potential medium-term revenue diversity, despite the 'Big Two' groups' overseas expansion further affecting profitability amid a current weak operating environment. These groups have had a high economic exposure to Japan, with earnings highly dependent on the domestic stock market. The 'Big Two' have so far followed conservative financing strategies and are reasonably well-capitalised. Fitch will however evaluate the capital adequacy of these groups under changing regulatory requirements.