Japan's Banks Could Benefit From Riskier Lending -- Heard on the Street

By Anjani Trivedi Features Dow Jones Newswires

Japan's mega banks are finally feeling the winds of change. The likes of Mitsubishi UFJ Financial Group, Sumitomo Mitsui Financial Group and Mizuho Financial Group have long struggled with anemic loan demand and deteriorating net interest margins. Now there are signs they are changing their strategies to offset those problems. Investors should hope the pressure keeps rising.

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One little-noticed recent shift is the banks' greater issuance of subordinated loans--riskier debt that puts lenders lower down the ranks of those who get repaid when a company goes bust. Japanese banks doled out $14 billion in such loans last year, according to Moody's Investors Service, almost equivalent to the combined total over the preceding four years. The trend has continued, with the top three banks behind all Japanese subordinated loan issuance this year.

Because of the higher risk involved in subordinated debt, which is typically uncollateralized, banks can charge higher interest rates. If that means keeping some "zombie" companies on life support, at least the banks are getting better rewarded for their pains.

That is not the only benefit. Big Japanese banks still often own large stakes in companies they lend to. In swapping old, collateralized loans for subordinated loans to companies, the banks are taking the opportunity to talk companies into letting them sell down these piles of legacy cross-shareholdings, which have long been an obstacle to reform in Japan. Companies can use the proceeds of the subordinated loans to buy back their shares from the banks, Moody's says.

If this trend continues at the current rate, banks could cull their holdings in companies by Yen3.7 trillion ($33.23 billion) over the next five years, Moody's reckons. That would help Japan's banks unleash trapped regulatory capital, improving their Tier 1 capital ratios by an estimated net 0.8 percentage point.

Previous bank strategies like ramping up overseas lending and buying assets with dollar deposits to fund such lending haven't brought much bang for their buck: Japan's lenders currently trade at 0.6 times their book value. The banks' latest shift, though, could raise their income while simultaneously helping reform Japan Inc. This could be more than just a strong gust; investors should keep an eye on the wind speed.

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Write to Anjani Trivedi at anjani.trivedi@wsj.com

(END) Dow Jones Newswires

May 29, 2017 05:13 ET (09:13 GMT)