Mitsubishi UFJ (NYSE:MUFG) Financial Group Inc, Mizuho Financial Group Inc, and Sumitomo Mitsui (NYSE:SMFG) Financial Group Inc have bolstered their US operations and are now focusing on business lending to lower-rated customers and underwriting trash bonds.
However, their timing - as interest rates rise and the high-yield loan market slows - means they will confront increased dangers and fewer possibilities, putting their viability to the test.
"Following the recent downturn, we'll need to actively watch the markets," said Shinichi Sato, an executive officer of Mitsubishi UFJ, Japan's largest lender.
He remained optimistic, though, stating that "the market for non-investment grade finance will almost certainly continue to develop."
The large Japanese banks still have a long way to go before they can be considered market leaders.
Mitsubishi UFJ, which has a joint venture with Morgan Stanley (NYSE:MS), had a 1.6 percent part of the estimated $18 billion non-investment grade debt market fees last year, according to Dealogic, the highest amount of any Japanese bank.
It intends to climb five positions to 12th place in the league table for non-investment grade bonds and loan syndication during the next two years.
KNOWLEDGE OF THE LOCAL AREA
Because non-investment grade debtors are seen to be more prone to fail, bankers believe that agreements need a greater focus on local circumstances.
Developing such knowledge has been difficult for Japanese banks, they say, necessitating a greater dependence on local people and the adoption of a more agile company culture.
Mizuho's position in the United States has grown after its 2015 purchase of Royal Bank of Scotland's (NYSE:RBS old old) North American corporate loan portfolio, which included the hiring of about 150 former RBS (LON:NWG) bankers.
"American banks and investment banks are cutting-edge in terms of business models and governance, and we have grown our footprint via the recruitment of bright bankers," said Yusuke Kasamatsu, a senior Mizuho banker.
"We incorporated their views and stepped up our game."
It strengthened relationships with investment-grade customers and subsequently expanded its reach to lower-rated borrowers as its understanding grew, Kasamatsu said.
Rivals took note in 2020, when Mizuho's revenues from the United States business increased significantly, according to a top official at another megabank.
"The RBS transaction altered their culture," the executive added, refusing to be named due to the topic's sensitivity. "They accelerated the due diligence process and strengthened risk management. Former RBS bankers advised them on necessary changes, and they listened."
Its securities business in the United States more than doubled profits to 60 billion yen ($467 million) in the fiscal year ending March 2021, after a year-earlier tripling.
According to Dealogic, its portion of the high-yield fee pool is 1.5 percent and has grown in the last three years.
Sumitomo Mitsui acquired a 5% investment in Jefferies Financial Group Inc last year, in part to pursue high-yield projects.
"Because our skills in the United States were limited, we were unable to fully benefit from the booming capital markets" that aided Mizuho's growth, Sumitomo Mitsui CEO Jun Ohta said in a December interview.
NEW DANGERS
However, the development in the US, particularly in the high-yield loan market, would create new dangers for the large lenders.
The Bank of Japan has taken note, stating that although exposure to high-risk assets is limited, it may expose lenders to unexpected losses.
As banks seek more fee income, the central bank has said that they must "review the quality and risk of their portfolios."
While Japanese financial institutions often hedge against default risk by reselling loans in the secondary market, they have been burned before on Wall Street.
Nomura Holdings (NYSE:NMR) suffered a $2.9 billion loss last year as a result of the failure of hedge fund Archegos Capital. Mizuho was the worst-hit Japanese bank during the subprime crisis, losing around $6 billion.
An official at the Financial Services Agency said it was "acceptable" for banks to join the high-yield market abroad after having expertise with investment-grade debt.
"It's also critical to enhance their risk management structure in accordance with their plans, and we're actively monitoring that," the official, who requested anonymity, added.
Banks must understand how much risk they can tolerate during periods of market hardship, according to Rie Nishihara of JPMorgan (NYSE:JPM) Securities in Japan.
There is a difference in the speed with which top-tier and second-tier banks can get information in these instances, she said, citing the Archegos collapse, from which top-tier investment banks escaped relatively unharmed.
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