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Japan's regional banks take big hits from shedding foreign debt

Sector cuts losses now to avoid even more pain later

Regional banks' exposure to foreign debt securities made the headlines when Shizuoka Bank booked large losses in 2016 from selling bondholdings.

TOKYO -- Japanese regional banks are swallowing quarterly losses on bondholdings several times larger than a year earlier as they sell off foreign debt that has declined in value, aiming to avert massive paper losses down the road.

Eighty listed regional banks or banking groups reported a combined 25 billion yen ($224 million) in bond transaction losses for the three months ended June -- an eightfold increase on the year. Mebuki Financial Group was the biggest loser at 6.5 billion yen, followed by San-in Godo Bank at 3.7 billion yen.

The losses resulted directly from banks selling off foreign bonds at a loss. In Mebuki's case, the combination of rising yields on U.S. Treasurys -- which move inversely to their value -- and the steeper costs of procuring the dollar worsened the cost-benefit ratio of holding American debt. Mebuki redirected a portion of the proceeds toward European sovereign bonds.

Regional banks suffered a combined loss from bond transactions for two consecutive fiscal years through March 2018. The 121.3 billion yen loss recorded for fiscal 2017 was most recently dwarfed only by the 676.8 billion yen loss of fiscal 2008, which saw the outbreak of the global financial crisis.

The issue initially came into focus when Shizuoka Bank booked losses of 25 billion yen on the sale of U.S. Treasurys and other assets for the three quarters through December 2016. Senshu Ikeda Holdings recorded 13.1 billion yen in losses for the April-June quarter of 2017.

In overall earnings, the 80 regional banking institutions appear healthy at first glance. April-June net profit jumped 20% on the year to 366.4 billion yen overall, results released through Tuesday show.

But regional banks are actively cutting their losses on foreign debt in response to concerns expressed by the Financial Services Agency. The FSA recently looked into the extent that yield-hungry banks, willing to take on outsize risks for short-term gains, ignore mounting paper losses from foreign debt.

The agency found that regional banks will shoulder more than triple the quantified risk compared with Japan's biggest banks under a scenario where Japanese government bond yields rise. If yields at home and abroad climb 50 basis points from the end of March 2018, the FSA estimates, then more than a quarter of the regional banks will generate unrealized losses exceeding annual core net business income. The share tops 50% if yields rise by a full point.

Sixty-four regional banks owned more than 66 trillion yen in securities as of May, according to data from the Bank of Japan. JGBs accounted for 31%, while U.S. Treasurys and other foreign securities constituted more than 13%. The balance of JGBs plunged 30% since the BOJ instituted its negative-rate policy in February 2016, while the sum of foreign securities declined 20%.

The interim half ending in September will be the first since the BOJ tweaked its ultraloose policy in late July to tolerate wider fluctuations in benchmark JGB yields. With regional banks holding more than twice as much in JGBs as in foreign bonds, "the impact will be incomparably greater than for foreign debt," an industry source predicted.

Regional banks also risk being squeezed by paper losses on JGBs if yields jump. Before the latest BOJ action, JPMorgan Securities Japan had already forecast that 10 or so regional banks, or 10% of the total, would realize pretax losses in fiscal 2020. If rising interest rates apply additional downward pressure on portfolio values, "potential loss-makers will increase to about 40 banks," said Rie Nishihara, senior analyst at JPMorgan Securities Japan.

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