Struggling to revive profits as low yields persist, a handful of troubled regional banks are wading deeper into riskier credit such as near-junk rated overseas bonds, according to a Bloomberg survey.
Weaker regional lenders are fighting for survival as the government presses for consolidation in the industry, which has been wracked by shrinking rural populations. Unlike mega-banks, which can mitigate the blow from negative interest rates by diversifying more into businesses like investment banking, regional lenders sometimes lack the resources for such shifts.
The country’s low rates have forced some traditionally conservative local lenders to dive into riskier assets after cutting holdings of Japanese government bonds, which had been their mainstay.
Of 29 regional banks that participated in the survey, 20 said they had reduced JGB holdings. Five said they had bought foreign notes with ratings at the triple B level — the lowest credit score group before junk. While that’s hardly a majority, the fact that any are buying such securities marks a dramatic shift from the days when the lenders were content to hold only higher-rated debt.
“The banks are more vulnerable to losses from investments, because their high-risk investment assets have grown,” said Shunsaku Sato, a senior credit officer at Moody’s Investors Service.
One bank even said it no longer owns JGBs. Two responded that they own collateralized loan obligations, or CLOs. Others answered that they have bought residential mortgage-backed securities and debt offering relatively attractive coupons such as Tepco Power Grid bonds.
“Smaller banks, which are experiencing big drops in profits, are desperate, and so they are taking deeper credit risks,” remarked Ryoji Yoshizawa, senior director at S&P Global Ratings. If the banks’ risk exposure exceeds expectations, S&P’s assessment may change, he said.
He acknowledged that under the current low-yield environment where regional banks face declining profitability, they would have to take more risks to compensate.
The Bloomberg survey focused on so-called first-tier regional banks, which are the biggest such lenders with branches in major regional cities. The survey was conducted from late November to early December.