DAIWA DAIWA INSTITUTE OF RESEARCH LTD. 6 December 2007 (No of pages: 19) Earnings Analysis of Major Banks–I —1H FY07 Earnings Summary and Operating Environment— (Sumitomo Mitsui Banking Corp is affiliated with Daiwa Securities SMBC. See disclaimer below.) Equity Research Dept Akira Takai • Major banks’ aggregate 1H FY07 parent real net business profit (total sum of group banks) edged down 2.6% y/y to Y1,614.8 billion. Domestic net interest income expanded, mainly thanks to improvement in loan-deposit interest rate spreads. Treasury operations apparently improved overall, helped by lower overseas interest rates. Meanwhile, slow growth in net fee/commission income and an increase in overhead weighed on profit. • However, the main factor dragging down profit was aggregate credit costs net of recoveries, which reached Y366.1 billion, reversing course net credit recoveries of Y244.9 booked a year earlier. A number of banks took a hit from earnings deterioration at group non-banks and higher income taxes due to the realization of deferred tax assets during the year-earlier period. This capped aggregate consolidated net income at Y947.9 billion, 45.4% below the 1H FY06 figure, which was the highest in history. However, solid profitability prompted some banks to resume or raise common dividends in 1H. • The BOJ did not raise interest rates in 1H, after having lifted the unsecured overnight call rate 0.25% twice in FY06. The bond market retreated in 1Q but began to rebound in 2Q. Meanwhile, global equity markets pulled back in response to the deepening subprime loan crisis in August, causing Japanese equities to plummet. However, the Fed cut the federal funds rate in the latter half of September, sparking a recovery in the equity market which lifted TOPIX to a notch below the end-March level at end-September 2007. • For FY07, major banks envisage a 2.2% drop in aggregate real net business profit on a parent basis. Since recoveries of loan-loss reserves have peaked, credit costs should normalize at low levels. Some banks foresee a considerable profit decline, mainly on the absence of lower income tax payments, so consolidated net income is expected to slide 21.2% y/y to Y2,225 billion. The majority of major banks intend to raise dividends, believing that the overall impact from the subprime loan fiasco will be minor. The originator of this report, Daiwa Institute of Research (DIR), and the main users, Daiwa Securities and Daiwa Securities SMBC, are subsidiaries of Daiwa Securities Group. Daiwa Securities Group, DIR, Daiwa Securities, Daiwa Securities SMBC, and other group companies may hold, buy, and sell shares in companies mentioned in this report. Daiwa Securities and Daiwa Securities SMBC offer investment banking services and may make a market for stocks mentioned in this report. IMPORTANT DISCLOSURES, INCLUDING ANY REQUIRED RESEARCH CERTIFICATIONS, ARE PROVIDED ON THE LAST TWO PAGES OF THIS REPORT. Japanese Equity Research 1. Summary of 1H FY07 Results Real net business profit In 1H FY07, major banks’ parent* aggregate net business profit climbed 3.3% y/y to rose 2.6% to Y1,614.8 Y1,611.4 billion (Chart 1). Aggregate real net business profit (net business profit billion before additions to/recoveries from general loan-loss reserves, plus credit costs for trust bank accounts), which indicates core profit levels, edged up 2.6% to Y1,614.8 billion. Overall, the figures came in nearly on par with banks’ initial projections. Wider loan-deposit Looking at major factors impacting core profit, loan growth in mainstay domestic interest rate spreads, lending operations undershot bank projections, but rate hikes since last year improved recovery in treasury the loan-deposit interest rate spread, albeit slightly. Major gaps opened up between income, weak growth in banks, but combined treasury income recovered, underpinned by wider spreads due to net fee/commission lower overseas interest rates and improvement in net bond-related gains/losses vs. the income, and higher massive losses booked in 1H FY06. Sales commissions from the investment trusts and overhead other financial products remained solid, but wholesale securities operations fared poorly. Overhead remained on an uptrend, with both personnel and non-personnel costs rising across the subsector. Net credit costs increased As for non-operating items, aggregate net credit costs swelled to Y366.1 billion, the to Y366.1 billion; net largest drag on profit in 1H. In comparison, 1H FY06 earnings gained from Y244.9 equity-related losses billion in net credit recoveries. Negatives included contraction in loan-loss reserve reached Y2 billion releases and write-off recoveries, lower internal credit ratings for some major borrowers, and higher provisions for losses on loans to many medium-sized companies and SMEs. Aggregate net equity-related losses reached Y2 billion (vs. the year-earlier Y134.5 billion in net equity-related gains), largely because Sumitomo Mitsui booked hefty impairment losses on shareholdings of non-banks. Losses related to Aggregate consolidated losses pertaining to the subprime loan fiasco were capped at subprime loan crisis Y113.9 billion, including impairment charges and losses on the sale of securitized limited to Y113.9 billion products, as well as related provision expenses. The crisis hit banking groups differently, but on the whole, major banks’ low exposure to such products translated into lower damage than at overseas financial institutions. Consolidated net income Income tax payments returned to normal at almost all banks, in stark comparison to the plunged 45.4%, but some year-earlier period, when the realization of deferred tax assets reduced taxes at many banks resumed and lifted banks (notably, deferred tax assets surged as high as Y231 billion at Resona Bank in 1H dividends 1H FY06). Also, significant losses at subsidiaries Mizuho Securities and Mitsubishi UFJ Nicos dragged down consolidated earnings at Mizuho Financial Group and Mitsubishi UFJ Financial Group, respectively. As a result, aggregate net income plunged 49.1% y/y to Y821.9 billion on a parent basis and slid 45.4% to Y947.9 billion on a consolidated basis. However, we believe aggregate net income approached normal levels in 1H FY07, as the record figure a year earlier owed heavily to one-time factors (net credit recoveries and lower income taxes). Also in 1H FY07, stable profitability prompted some banks to resume or raise common dividends. * In calculating aggregate major bank parent figures, we added group bank figures for banking groups under holding company structures. Thus, Mizuho Financial Group represents the sum of Mizuho Bank and Mizuho Corporate Bank. Likewise, Mitsubishi UFJ Financial Group is the sum of (1) Bank of Tokyo-Mitsubishi UFJ (formerly Bank of Tokyo Mitsubishi and UFJ Bank) and (2) Mitsubishi UFJ Trust & Banking (formerly Mitsubishi Trust & Banking and UFJ Trust Bank). Others are as follows: Sumitomo Mitsui Financial Group (Sumitomo Mitsui Banking), Resona Holdings (Resona Bank and Saitama Resona Bank), and Mitsui Trust Holdings (Chuo Mitsui Trust & Banking and Mitsui Asset Trust & Banking). 2 Earnings Analysis of Major Banks–I 1H FY07 Parent Results (period-end; Y bil) Chart 1 Ordinary Real net Net Ordinary Net Total DPS 4) Total Share- income 1) business business profit income credit (Y) assets holders' profit 2) profit costs 3) equity, etc 5) Mizuho 1H FY06 601.2 216.6 216.6 209.7 125.4 -5.3 - 68,678.1 1,934.0 1H FY07 687.8 199.7209.7 96.0 100.9 -81.8 - 66,769.31,881.1 % chg 14.4 -7.8-3.2 -54.2 -19.6 - - -2.8-2.7 Mizuho Corporate 1H FY06 809.5 137.5 137.5 201.5 213.3 96.2 - 63,409.4 3,148.2 1H FY07 1,078.2 178.3 178.3 188.8 173.8 6.2 - 66,260.0 3,250.1 % chg 33.2 29.629.6 -6.3 -18.5 - - 4.53.2 Sum of Mizuho 1H FY06 1,410.8 354.2 354.2 411.1 338.7 91.0 - 132,087.6 5,082.2 2 banks 1H FY07 1,766.0 378.0 388.0 284.8 274.7 -75.6 - 133,029.3 5,131.2 % chg 25.2 6.79.6 -30.7 -18.9 - - 0.7 1.0 8411 Mizuho Financial 1H FY06 1,234.4 - - 1,219.7 1,241.8 - 0.00 4,772.2 3,178.8 Group 1H FY07 604.9 - - 588.3 626.5 - 0.00 4,623.6 3,328.4 % chg -51.0 -- -51.8 -49.6 - - -3.14.7 Tokyo-Mitsubishi 1H FY06 1,694.9 426.1 426.1 358.4 422.9 178.8 - 140,550.7 6,733.1 UFJ 1H FY07 1,941.9 389.2 397.7 272.2 188.1 -130.0 - 137,208.7 6,890.7 % chg 14.6 -8.7-6.7 -24.0 -55.5 - - -2.42.3 Mitsubishi UFJ 1H FY06 346.1 122.8 122.7 127.3 112.6 49.0 - 19,540.6 1,563.3 Trust 1H FY07 344.3 115.6 114.3 97.8 60.7 -8.4 - 18,973.6 1,526.7 % chg -0.5 -5.8 -6.9 -23.2 -46.1 - - -2.9 -2.3 Sum of MUFG 1H FY06 2,041.1 548.9 548.9 485.6 535.5 227.8 - 160,091.3 8,296.4 2 banks 1H FY07 2,286.1 504.8 512.0 370.0 248.8 -138.4 - 156,182.3 8,417.4 % chg 12.0 -8.0-6.7 -23.8 -53.5 - - -2.4 1.5 8306 MUFG 6) 1H FY06 163.6 - - 146.6 146.8 - 5,000.00 7,464.65,982.5 1H FY07 197.2 - - 183.0 105.5 - 7.00 7,677.3 6,670.0 % chg 20.5 -- 24.8 -28.2 - - 2.811.5 Sumitomo Mitsui 1H FY06 1,115.7 311.6 311.6 269.1 183.6 -33.2 - 93,149.2 3,492.4 Banking 1H FY07 1,307.7 390.9 383.1 157.8 63.8 -114.2 - 94,307.2 3,856.3 Corporation % chg 17.2 25.4 22.9 -41.3 -65.3 - - 1.2 10.4 8316 Sumitomo Mitsui 1H FY06 321.3 - - 319.1 318.2 - 0.00 3,929.8 3,252.2 Financial Group 1H FY07 23.9 - - 11.7 9.4 - 5,000.00 4,001.5 2,940.1 % chg -92.6 -- -96.3 -97.1 - - 1.8-9.6 Resona 1H FY06 400.6 117.8 117.2 143.4 386.8 -15.8 - 27,373.6 1,368.6 1H FY07 362.8 98.0 113.2 71.5 87.8 -5.3 - 26,597.1 1,173.7 % chg -9.4 -16.9 -3.4 -50.1 -77.3 - - -2.8 -14.2 Saitama Resona 1H FY06 94.1 38.9 35.7 32.2 19.0 -3.7 - 9,502.9 271.2 1H FY07 109.0 44.6 46.8 39.1 23.0 -4.4 - 9,520.2